Lernmaterialien für Principles of MacroEconomics an der ETHZ - ETH Zurich

Inflation distorts relative prices

If prices of some goods are “sticky” (e.g. because of menu costs) relative to other goods, then inflation is creating changes in relative prices that lead to decisions of market participants that are economically inefficient in the sense that it deviates from the optimal allocation of resources

Hence, markets are less able to allocate resources to their best use

By the supply and demand for money. 

Shoeleather costs are the resources wasted when inflation encourages people to reduce their money holdings.

Inflation reduces the real value of money, so people have an incentive to minimize their cash holdings.

Less cash requires more frequent trips to the bank to withdraw money from interest-bearing accounts

The actual cost of reducing your money holdings is the time and convenience you must sacrifice to keep less money on hand

Also, extra trips to the bank take time away from productive activities

When the Central Bank increases the money supply and creates inflation, it erodes the real value of the unit of account

Inflation causes dollars at different times to have different real values

Therefore, with rising prices, it is more difficult to compare real revenues, costs, and profits over time

Menu costs are the costs of adjusting prices

During inflationary times, it is necessary to update price lists and other posted prices

• This is a resource-consuming process that takes
away from other productive activities

• a policy variable that is controlled by the central bank
• Through instruments such as open-market operations, the CB affects the quantity of money supplied
• Therefore the supply of money is (assumed to be) vertical (perfectly inelastic)

Reserve requirements are regulations on the minimum amount of reserves that banks must hold against deposits.

Increasing the reserve requirement decreases the money supply.

Decreasing the reserve requirement increases the money supply.

The CB conducts open-market operations when it buys government bonds from or sells government bonds to the public:

When the CB buys government bonds, the money supply increases.

The money supply decreases when the CB sells government bonds.

The Liquidity of an Asset. Liquidity is the ease with which an asset can be converted into the economy’s medium of exchange.

The Kinds of Money. 

• Commodity money takes the form of a commodity with intrinsic value.
• Fiat money is used as money because of government decree.t does not have intrinsic value.

Money in the Economy.

• Currency is the paper bills and coins in the hands of the public.
• Demand deposits are balances in bank accounts that depositors can access on demand.

In a fractional-reserve banking system, banks hold a fraction of the money deposited as reserves and lend out the rest.

The reserve ratio is the fraction of deposits that banks hold as reserves.

are deposits that banks have received but have not loaned out.