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Money supply measures April 2002 Symbol Assets included C Currency Amount billions 598 7 M1 C demand deposits 1174 0 travelers checks other checkable deposits M2 M1 small time deposits savings deposits money market mutual funds money market deposit accounts 5480 1 M3 M2 large time deposits repurchase agreements institutional money market mutual fund balances 8054 4 slide 1 slide 2 slide 3 slide 4 slide 5 The social costs of inflation fall into two categories 1 costs when inflation is expected 2 additional costs when inflation is different than people had expected slide 6 The costs of expected inflation 1 shoeleather cost def the costs and inconveniences of reducing money balances to avoid the inflation tax i real money balances Remember In long run inflation doesn t affect real income or real spending So same monthly spending but lower average money holdings means more frequent trips to the bank to withdraw smaller amounts of cash slide 7 The costs of expected inflation 2 menu costs def The costs of changing prices Examples print new menus print mail new catalogs The higher is inflation the more frequently firms must change their prices and incur these costs slide 8 The costs of expected inflation 3 relative price distortions Firms facing menu costs change prices infrequently Example Suppose a firm issues new catalog each January As the general price level rises throughout the year the firm s relative price will fall Different firms change their prices at different times leading to relative price distortions which cause microeconomic inefficiencies in the allocation of resources slide 9 The costs of expected inflation 4 unfair tax treatment Some taxes are not adjusted to account for inflation such as the capital gains tax Example 1 1 2001 you bought 10 000 worth of Starbucks stock 12 31 2001 you sold the stock for 11 000 so your nominal capital gain was 1000 10 Suppose 10 in 2001 Your real capital gain is 0 But the govt requires you to pay taxes on your 1000 nominal

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