chapter 5: inflation

• What is inflation?


  Continuous increase in price levels.
• What happens to the purchasing power of money when the price level rises?


  The purchasing power of money falls by the same degree.
• What is the difference between inflation and a change in relative prices?


  Inflation is a general change in price levels, while a change in relative prices affects only certain prices.
• How is inflation typically calculated?


  By using a "basket of goods" compiled into an index.
• What does the consumer price index (CPI) represent in Switzerland?


  The CPI is used to measure the average expenditure of a household over time.
• How often does the composition of the basket of goods change in Switzerland?


  Every five years.
• Why is the CPI important for monetary policy?


  It forms the basis for calculating cost of living adjustments and helps the SNB make decisions.
• What is the formula to calculate inflation rates?


  Inflation rate = \(\frac{(final value - initial value)}{initial value} \times 100\) / years.
• What are the three roles of money?

  • Medium of exchange: Facilitates efficient economic exchange.
  • Store of value: Allows purchasing power to be delayed.
  • Unit of measure: Expresses all prices in monetary units for easy comparison.
• What is the most efficient way to establish money supply?

  By creating an official government monopoly through the central bank.
• What does the monetary base include?


  Cash and sight accounts of commercial banks with the central bank.
• What are the definitions of money supply M1, M2, and M3?

  M1 includes demand deposits; M2 includes M1 plus savings accounts; M3 includes M2 plus time deposits.
• What is the money multiplier formula?


  Money multiplier = \(\frac{1}{reserve rate}\).
• If the reserve rate is 10%, what is the money multiplier?


  10.
• How does the central bank alter the money supply?


  By conducting transactions with commercial banks through open market policy.
• What happens when the central bank pursues an expansionary monetary policy?


  The money supply is increased by purchasing securities.
• How does the money multiplier affect liquidity?


  It increases liquidity by allowing banks to issue more loans based on reserves.
• What is the quantity equation in relation to money and inflation?


  Price level x Real GDP = money supply x Velocity of money.
• What happens if the money supply increases excessively over time?


  It leads to a proportional increase in price levels, resulting in inflation.
• What is deflation?


  Deflation is when price levels fall over longer periods, usually due to a decline in overall economic demand.
• What are the costs of inflation?


  Transaction costs, costs of insecurity, distortion in relative prices, costs for lenders, and costs from cold progression in taxes.
• What is hyperinflation?


  Hyperinflation is a monthly inflation level of more than 50% compared to the previous month.
• How does inflation affect long-term contracts?


  High inflation increases insecurity and makes long-term contracts unattractive.
• What is the impact of inflation on lenders?


  Inflation reduces the real value of interest payments, leading to losses for lenders.
• What is the cost of fighting inflation?

  Fighting inflation often leads to a recession and rising unemployment due to reduced economic demand.
• What happens during deflation?


  Price levels fall, leading to increased value of money and decreased overall economic demand.
• What are the costs of moderate inflation?


  1. Transaction costs: Increased costs of trading goods/services.
  2. Costs of insecurity: Long-term contracts become unattractive.
  3. Costs of distortion in relative prices: Prices change at different rates.
  4. Cost for lenders: Real value of interest payments decreases.
  5. Cost from cold progression in taxes: Higher taxes without real income increase.
• What are the effects of expansive monetary policy on inflation?


  • Inflation tends to rise if monetary policy is expansive.
  • Demand exceeds normal capacity, leading to price increases.
  • In a recession, oversupply can lead to deflation.