Group 6

Money Growth
and Inflation
 Lara Setiari (12)
Niarmi Jenifer (13)
Juli Adi Swara (14)
 THE CLASSICAL
1 THEORY OF INFLATION

THE LEVEL OF PRICES

2 AND THE VALUE OF
MONEY

Contents 3
THE EFFECT OF A
MONETARY INJECTION

THE CLASSICAL
4 DICHOTOMY AND
MONETARY NEUTRALITY

VELOCITY AND
5
THE QUANTITY
EQUATION
 THE INFLATION
6
TAX

THE FISHER
7
EFFECT

8
THE COST OF Contents
INFLATION

POSITIVE EFFECT OF
9 INFLATION

NEGATIVE EFFECT OF
10 INFLATION
The Classical Theory of
Inflation
The classical theory is sometimes called the “quantity
theory of money,”
More specifically, the classical theory of inflation
explains how the aggregate price level is determined
through the interaction between money supply and
money demand.
The classical theory must qualify as one of the oldest
“microfounded” models in all of macroeconomics.
 The Level of Prices and The
Value of Money
The economy’s overall price level can be viewed in
two ways.
When the price level rises, people have to pay
more for the goods and services they buy.
Alternatively, we can view the price level as a
measure of the value of money. A rise in the price
level means a lower value of money because each
rupiah in your wallet now buys a smaller quantity
of goods and services.
The graph measures the quantity of money M along the
horizontal axis and the “price” of money 1/P along the
vertical axis.
 Money Supply, Money
Demand, and Monetary
Equilibrium
The supply and demand for money determines the value of
Money.
First, consider to money supply. In Indonesia, the Central Bank of
Indonesia Reserve, together with another Bank, can determine
the supply of money.

Now consider money demand. Although many variables affect

the demand for money. one variable stands out in importance:
the average level of prices in the economy. People hold money
because it is the medium of exchange.
Vision

At the equilibrium, shown in the figure as point A, the quantity of money

demanded balances the quantity of money supplied. This equilibrium of
money supply and money demand ~ determines the value of money and
the price level.
 The Effects of a
Monetary Injection
In Indonesia, the Institution that holds the monetary
policy is Bank Indonesia (BI). BI divides the money based
on how the interaction between the monetary institution,
general, banks the people make a supply and demand of
money. There are three kinds of money :

1. Cartal Money 2. Demand Deposit 3. Quasi

(Currency) (Giral Money) Money
 l M o n e y (Cu
t a rr
ar en
C c

y)
Cartal Money (Currency)
Currency or base money is money that is outside
financial institutions plus financial institution reserves.
This money in the curve quantity of money is M0.

It has characteristics: the form of the money is bank

notes (money from paper) and coins, spread by the
government or an institution trusted by the government
 M oney (Gira
n d l M
a o
e m n

ey
)
Demand Deposit (Giral Money)
Demand deposits are money that is not held by the public
directly, but is in the form of accounts issued by commercial
banks. Demand deposits and currency are included in near
money or have the symbol M1.

It has characteristics: Not in physical form like paper and

metal, Spread by a private bank in the form of an account or
checking account, and cannot be used for direct transactions.
 u a s i M one
Q y

Quasi money is a type of money that is relatively less

liquid and its use is very time bound. Meanwhile, Bank
Indonesia defines quasi-money as assets that can be
cashed quickly. Quasi- money has a symbol M2.

Some examples of quasi-money are as follows: Savings at

the bank, Time deposits, and Domestic private foreign
currency savings accounts.
 The Classical Dichotomy
and Monetary Neutrality

The classical dichotomy is the idea, attributed to classical and pre-

Keynesian economics, that real and nominal variables can be analyzed
separately. The nominal variables are variables we use to measure in
monetary units and the real variables are variables measured in physical
units.
For the analysis in the Classical Dichotomy changes in the supply of money
affect nominal variables but not real ones. When the central bank doubles the
money supply, the price level doubles, the currency wage doubles, and all other
currency values double. Real variables, such as production, employment, real
wages, and real interest rates, are unchanged, this irrelevance with a real
variable we call Monetary Neutrality.
 Velocity and The Quantity
Equation
velocity of money is, we divide the nominal value of output (nominal GDP) by the quantity of
money. If P is the price level (the GDP deflator), Y is the quantity of output (real GDP), and M
is the quantity of money, then velocity is:

V = (P x Y) / M
To see why this makes sense, imagine a simple economy that produces only
palm oil. Suppose that the economy produces 100-ton palm oil in a year, that
palmlam oil sells Rp. 2500kg, and that the quantity of money in the economy is
Rp. 100,000. Then the velocity of money is
100 x (2.500 x 1.000) / 100.000 = 2.500
In this economy, people spend a total of Rp. 250.000.000 per year on palm. For
this Rp 2.500 of spending to take place with only Rp.100.00 of money, each
dollar bill must change hands on average 2.500 times per year.
 Velocity and The Quantity
Equation

When we rearrange the formula of Velocity and make rotation to money, that will
give us this equation:
MxV=PxY

This equation states that the quantity of money (M) times the velocity of money (V)
equals the price of output (P) times the amount of output (Y). It is called the quantity
equation because it relates the quantity of money (M) to the nominal value of output
(P × Y). The quantity equation shows that an increase in the quantity of money in an
economy must be reflected in one of the other three variables: The price level must
rise, the quantity of output must rise, or the velocity of money must fall.
 I n f l a t i o n
he Ta
T x
Inflation Tax is the rise of revenue the monetary
institutions like Bank Central and the Government
want to get after they create money.
When the government raises revenue by printing
money, it is said to levy an inflation tax.
Instead, the inflation tax is subtler. When the
government prints money, the price level rises, and
the currency in your wallet become less valuable.
Thus, the inflation tax is like a tax on everyone who
holds money.
 F i s h e r Eff
h e ec
T t
Interest rates are important
variables for macroeconomists to 1. The Nominal Interest
understand because they link the
rate
economy on today and economy of
the future through their effects on
saving and investment. To 2. The Real Interest
understand the relationship between rate
money, inflation, and interest rates,
recall the distinction between the
nominal interest rate and the real
interest rate.
 1. The Nominal Interest rate
the nominal interest rate is the sum of the real
interest rate and the inflation rate:
𝑅𝑒𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 = 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 + 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒.

2. The Real Interest rate

The real interest rate is the nominal interest rate
minus the inflation rate:
𝑅𝑒𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 = 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 − 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒.

This adjustment of the nominal interest rate to the

inflation rate is called the Fisher effect,
 C o s t s o f I n f lati
T h e
on

The cost of inflation is the negative consequences

for the economy resulting directly or indirectly from
inflation. Inflation occurs when goods and services
price getting more expensive over time. If inflation
rises to levels that are too high, it can damage the
economy.

in general Inflation can we categorize into two main

ones. These are demand-pull inflation and cost-
push inflation.
 e s o f I n f lat
y p i
T on

1
Hyperinflation

2
Stagflation

3
Deflation
 i v e E f f e c t s o f I
g a t n f lat
N e ion
1
Value of money decreases

Briefly elaborate on what

you want to discuss. 2
Inequality

3
Cost of living goes
4 up
 i v e E f f e c t s o f I
s i t n f l a
P o tio
n

Rise in investments

Reduce debt
 Main parties involved and
their roles in Cost of
Inflation
1. Consumers
Consumers tend to have little benefit
from inflation, especially if their pay does
not increase when the rate of inflation
does. They suffer from the higher prices
of goods/services while still having the
same amount of money.
2. Investors
Investors actually tend to benefit a bit
if their stocks are in the sectors hit by
inflation. For example, if you're an
investor and you have stocks in the
gasoline sector, then you might notice
an increase in your stock prices due to
the gas prices going up.
 Conclusion
Inflation can occur because the amount of money grows too quickly, resulting in an
increase in the price level for purchasing goods. When price levels are so high we need to
pay more to buy the goods and services we want. However, when inflation occurs, a new
balance will definitely be created because of monetary injections which will increase the
amount of money in circulation for us to use, and also increase the demand for money so
that this new balance changes people's purchasing power to become lower. To know how
the quantity of money works we need to understand quantity of money in an economy
must be reflected in one of the other three variables: The price level must rise, the quantity
of output must rise, or the velocity of money must fall and to count the velocity of money
we can divine the value output and the quantity of money. in general Inflation cause by
demand-pull inflation and cost-push inflation. to deal with inflation we need to make a long
term investmen, make diversity to our portfolio (asset), avoiding keeping too much cash,
holding tangible Assets
 h a n k Y o
T u