Money, Banking, and Finance Chapter 11

Where Do Hyperinflations Come From?

• Hyperinflation usually happens if the government starts using the printing press to pay for its expenditure (because it does not manage to collect sufficient revenue)
• If the economy is large and growing and there are not too many newly printed bills, the money usually is just absorbed
• However, if the governments prints too much money, there will be hyperinflation
• Germany 1920s
• Zimbabwe in 2007

What is the Danger of a Hyperinflation in Europe Today?

• No real danger
• Governments are not allowed to use the printing press to pay for their deficit (EU treaty)
• Even (recently agreed) purchases of government bonds by the ECB are limited
• Money in modern, developed economies comes into existence by other means (via the banking system)

Why is Inflation Disliked Even if it is Lower?

• It redistributes from creditors to debtors
• It might wipe out savings
• It makes planning difficult
• It hurts those with nominally fixed incomes (people on unemployment assistant, pensioners etc.)
• It creates “menu” costs

What About Falling Prices – Do They Bring Problems as Well?

• Deflation: when the aggregate price level falls
• Wealth is redistributed from debtors to creditors
• Debtors tend to be those who spend more – firms are usually debtors
• This might lead to bankruptcies and problems in the banking sector
• People might postpone spending
• There might thus be problems for aggregate demand

What is Money?

What is Money?

• We usually define money by its functions:
• Medium of Exchange—promotes economic efficiency by minimizing time spent in exchanging goods and services
• Must be widely accepted
• Must be divisible
• Must be easy to carry
• Must not deteriorate quickly
• Store of Value — used to save purchasing power; most liquid of all assets but loses value during inflation
• Unit of Account — used to measure value in the economy