Money and Inflation

Money is anything widely 1)__accepted__ as final payment for goods and services. Money makes it easier to trade, borrow, save, invest, and compare the 2)_____ of goods and services. Money makes trading easier by replacing barter with 3)_____ involving currency, coins, or checks. People consume goods and services, not money; money is useful primarily because it can be used to buy goods and services. Producers use 4)_____ resources, human resources, and capital goods (not money) to make goods and services. Most countries create their own 5)_____ for use as money.

As a store of value, money makes it easier for people to save and defer 6)_____ until the future. As a unit of account, money is used to compare the market value of different goods and services. Money encourages specialization by decreasing the costs of exchange.

The basic money 7)_____ in the United States consists of currency, coins, and checking account deposits.

Inflation is a general increase in the level of prices throughout the economy. The most widely recognized 8)_____ of inflation is the Consumer Price Index.

Unanticipated inflation alters the 9)_____ normally created by price signals in the economy. The incentive to save diminishes as inflation erodes the value of savings accounts and fixed incomes. The incentive to spend and to accumulate 10)_____ increases as consumers act in anticipation of rising prices and wages. Inflation creates additional uncertainty. Predicting the future is more 11)_____ and mistakes are more costly.

Long-term and/or expected inflation may cause individuals and firms to alter their behaviors in response to anticipated changes.

• Interest rates rise to cover the expected inflation rate.

• Investors search for "inflation proof" investments.

• Unions demand cost-of-living 12)_____ in contracts.

Inflation rarely occurs except as a consequence of rapid increases in a society's 13)_____ of money. The Federal Reserve System, an agency 14)_____ of but established by the federal government, controls the stock of money in the United States through monetary policy. The Fed enacts monetary policy by changing the discount rate, by changing the reserve requirement, and/or through open market operations. The Fed often faces political pressures from government, private interests, and the 15)_____ to follow policies that cause the money stock to grow too rapidly for price stability.

The use of price controls in the aftermath of an increase in the money supply disguises inflation without eliminating it, and may lead to complete disruption of the system of resource allocation.

Exercise 6. Match the terms (1-10) with their definitions (a-j).

1. Consumer Price Index (CPI) a. rewards or punishments for behavior

2. Discount rate b. all paper bills and coins in circulation, currency, travelers checks, and checkable deposits

3. Federal Reserve System c. the demand by the Federal Reserve that banks hold a minimum percentage of deposits on reserve, unavailable for lending

4. Incentives d. the buying and selling of government securities by the Federal Reserve System

5. Inflation e. the accepted common medium of exchange for goods and services in the marketplace that functions as the unit of account, a means of deferred payment, and a store of value

6. Interest rate f. an increase in the overall level of prices over an extended period of time

7. Money g. the price paid for borrowing or saving money

8. Money supply h. the most commonly used measure of inflation, calculated by comparing the price of a designated "market basket" of goods and services in the current year to its price in a base year

9. Open market operations i. it serves as the nation's central banking organization; its functions include processing checks, serving as the government's banker, and controlling the rate of growth of the money supply

10. Reserve requirement j. the interest rate charged to member banks on funds borrowed from the Federal Reserve

Exercise 7. Define the given terms.

inflation rate deflation price stability

demand-pull inflation real income nominal income

cost-push inflation money illusion

Exercise 8. Read the text below. Choose the best word to fill each gap from A, B, C or D below. There is an example at the beginning. 0).