Chapter 5 Definition Sheet - Inflation rate: the percentage increase in the average level of prices - Price: amount of money required to buy a good - Velocity: the number of times the average dollar bill changes hands in a given time period - Money market: economists like to think that there is a market for money (cash and checking account balances) - Money Demand: (M/P)d = kY - Quantity Equation: M x V = P x Y - Seigniorage: to spend more without raising taxes or selling bonds, the government can print money - Inflation tax: printing money to raise revenue causes inflation. Inflation is like a tax on people who hold money - Fisher Equation: I = r + pi - Fisher Effect: an increase in pi causes an equal increase in I; one for one relationship - Pi: actual inflation rate (not known until after it has occurred) - Pie: expected inflation rate - I – pie: ex ante real interest rate; the real interest rate people expect at the time they buy a bond or take out a loan - I – pi: ex post real interest rate; the real interest rate actually realized - Anticipated (expected) inflation: everyone knows inflation will be at a certain rate - Unanticipated inflation: inflation that take people by surprise - Shoeleather cost: the costs and inconveniences of reducing money balancesto avoid the inflation tax - Menu costs: the costs of changing prices - Relative Price Distortions: different firms change their prices at different times, leading to relative price distortions causing microeconomic inefficiencies in the allocation of resources - Unfair Tax Treatment: some taxes are not adjusted to account for inflation, such as the capital gains - General inconvenience: inflation makes it harder to compare nominal values from different time periods - Hyperinflation: pi > 50% per month- Transactions Velocity of Money: the ratio of the dollar value of all transactions to the money supply - Income Velocity of Money: the ratio of national income, as measured by GDP, to the money supply - Real Money Balances: the quantity of money expressed in terms of the quantity of goods and services it can buy; the quantity of money divided by the price level (M/P) - Quantity Theory of Money: the identity stating that the product of the money supply and the velocity of money equals nominal expenditure (MV =PY); coupled with the assumption of stable velocity, an explanation of nominal expenditure called the quantity theory of money - Nominal Interest Rates: the return to savings and the cost of borrowing without adjustments for inflation (Cf. real interest rate) - Real Interest Rates: the return to saving and the cost of borrowing after adjustment for inflation (Cf. nominal interest rate) - Real Variables: measured in constant dollars; adjusted for inflation - Nominal Variables: measured in current dollars; not adjusted for inflation - Classical Dichotomy: the theoretical separation of real and nominal variables in the classical model, which implies that nominal variables do notinfluence real variables - Monetary Neutrality: the property that a change in the money supply does not influence real