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Econ 100b

Created 4/30/1996
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Lecture Nine

Monetary Policy; Real and Nominal Interest Rates
(Economics 100b; Spring 1996)

Professor of Economics J. Bradford DeLong
601 Evans, University of California at Berkeley
Berkeley, CA 94720
(510) 643-4027 phone (510) 642-6615 fax
delong@econ.berkeley.edu
http://www.j-bradford-delong.net

February 7, 1996


How to Link the Quantity Theory to F(K, L)?
Controlling the Quantity of Money
Real and Nominal Interest Rates
The Fisher Effect; Ex-Ante and Ex-Post Real Interest Rates
Economic and Social Costs of Inflation


How to Link the Quantity Theory to F(K, L)?

How do you link up this "quantity theory" that claims to tell you what P times Y is, with our model of last week that told us that Y = F(K, L)?

"Very carefully"

Right answer comes later on in the course...

This week we settle for a not-very-wrong answer. Suppose (never mind how) all of a sudden people find themselves with a lot more currency--large bills airdropped from helicopters, say. In the standard circular flow diagram people goose up their spending...



But there are no more commodities for them to buy...

Hence prices rise a bunch...

And as prices rise a bunch, firms find themselves making profits, bid for workers, nominal wages rise, and eventually you get back to the same real equilibrium as far as commodities and real incomes are concerned, but the price level is higher. We get real variables from chapter 3's model, and nominal variables from the quantity equation.

Inflation = M growth + V growth - Y growth

How good is the quantity-theoretic approach to inflation?

Very good across countries (especially if some of the countries have truly outlandish rates of inflation)...

Not very good year-to-year...

OK--but not great--decade-by-decade



When has the US had inflation? Seignorage; direct seignorage--and implicit defaults on the government's debt...




Controlling the Quantity of Money

The quantity of money is the result of myriads of private decisions. How can the Federal Reserve--or anyone else--"control" it?




Real and Nominal Interest Rates

8% nominal interest rate; suppose inflation is 5%; how much "richer" are you after a year?


The Fisher Effect; Ex-Ante and Ex-Post Real Interest Rates

Irving Fisher; the "Fisher effect": i = r + π
The real interest rate--r-- is determined by equilibrium in the loanable funds market:
Sp = DEF + I(r)

The nominal interest rate is the sum of the real interest rate and expected inflation.

One-for-one shifts in nominal interest rates and expected inflation
T-bill rate and GDP deflator inflation rate:


Economic and Social Costs of Inflation


>

Econ 100b

Created 4/30/1996
Go to
Brad De Long's Home Page


Professor of Economics J. Bradford DeLong, 601 Evans
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax
delong@econ.berkeley.edu
http://www.j-bradford-delong.net/