Chapter 17

Chapter 17 is titled “money growth and inflation” and introduced inflation and the quantity theory of money, that as the quantity of money and the price level rises, the value of money falls. This leads to classical dichotomy, which is the separation of nominal values, measured in monetary units, and real values, measured in physical units, and monetary neutrality, which means that real variables are not affected by changes in the money supply. The chapter continues with the quantity equation, quantity of money times the velocity of money equals the price output times the amount of output, the inflation tax, the revenue the government raises by creating money, and the fisher effect, when the rate of money growth the long-run effect is higher inflation rate and higher nominal interest rate. The chapter concludes with the costs of inflation and deflation.

The costs of inflation are the shoeleather costs: the resources wasted when inflation encourages people to reduce their money holdings, menu costs: the costs of changing prices, increased variability of relative prices, unintended changes in tax liabilities, confusion and inconvenience, and arbitrary redistribution of wealth. I believe the worst to be inflation-induced tax distortions because it exaggerates the size of capital gain therefore increasing the tax burden on that income. As this raises the tax burden on saving, it could then depress the economy’s long-run growth rate. Deflation also faces menu costs and relative-price variability, however it is much less steady and predictable and leads to a redistribution of wealth away from debtors towards creditors. This would be a big problem for households because it would take more money from them, although they have less wealth. I agree with the Federal Reserve Board to worry more about deflation because it usually arises because of a bigger economic issue which reduces the overall demand for goods and services, which can lead to falling incomes and rising unemployment.