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Financial Institutions and the Federal Reserve System, delivered on 21 January 2010.

Run time: 01:04:02
Type: mp3 audio file
Bitrate: 128 kbps
Size: 58.6 Mb

21 Jan 2010 - Professor C

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  • Comments

I am confused by how you define inflation. You said that inflation is only caused by a growth in the money supply which exceeds the real growth of the economy.
By this I understand that you mean price inflation, defined as a rise in prices, but that's obviously not what you're talking about. A rise in prices can also be caused by an increase in demand or a decrease of supply, and this has nothing to do with the money supply at all.
If you mean monetary inflation, that would simply be any increase in the money supply whatever, so I'm certain you don't mean that.
What I must assume you mean is that a rise in nominal prices which does not reflect a rise in real prices constitutes inflation (whereby the definition of inflation would be a rise in prices caused by excessive "money" production). In confronting this point, I would refer you to this wonderful website,, where there is literature explaining how inflation actually does cause a rise in the real price of the goods whose nominal price it inflates, because inflation does not affect all prices equally or simultaneously. This is important, from what I gather, because it causes the malinvestment which ultimately leads to panics/depressions/recessions/slowdowns/jobless-recoveries/what-have-yous
If I've really missed your point, then I apologize for making assumptions. In any case I hope one or two of your students actually finds the topic interesting enough to pursue.

I like your lecture style; it's definitely engaging, which is difficult with a subject like macroeconomics.

Posted by: Alex Wheeler-s Friend - 22 Jan 2010 - 09:47:36

Good morning, Mr. Wheeler, and thank you for posting a comment.

The error in your chain of thinking is evidenced by this statement:

A rise in prices can also be caused by an increase in demand or a decrease of supply, and this has nothing to do with the money supply at all.

In fact, a rise in the price of a given good or service can be the result of an increase in demand for or a decrease in the supply of that good or service. A microeconomic price effect is entirely different from a macroeconomic effect because, in the macroeconomy, effects are on aggregate demand and aggregate supply, which are operating in aggregate real output and aggregate price level space.

It is only when the aggregate price level changes that we are definitionally dealing with inflation and deflation.

As I explained during this lecture, if the price of a single product rises, the consumer market will substitute away from that product to the extent possible, thereby reducing the quantity demanded of that product and the demand for its complements. To the extent that the consumers of that good choose not to substitute away, their incomes available for other goods and services will be diminished by the price effect. Concomitantly, to the extent that the consumers of the good do substitute away because of the price increase, the demand for substitutes will increase, again to the extent that substitution is possible. In the end, though, the aggregate price level will not change because real income has not changed, so the consumer side of the market will merely allocate its unchanged income across an altered bundle of goods.

If, however, a monetary authority were to infuse new money into that consumer market's pockets, then the consumers could absorb the price increase in that one good and not change their demand allocation for all other goods. (This is done by the Federal Reserve when it "monetizes a price shock," as during the OPEC oil embargo of the early '70s, and as it did during the financial crisis of 2008 to the present.)

When no money is infused, one product's price goes up, but others must compensationally change so the aggregate price level does not change; but if new money is put into the consumers' pocketbooks, thereby shifting the aggregate demand curve, then that one price increase can stand without other prices compensating, which means the overall, aggregate price level has gone up.

In the left sidebar, here, you will find the links to the four parts of my series, "The Economics of Wreckage," where this is all explained in excruciating (but obviously engaging) detail.

Also, you might be interested in watching a video I produced a couple years ago. The video quality is only so-so, and the audio is downright amateur, given that I was using pretty low-end equipment back then. That having been noted, you will find the lecture both entertaining (especially the second half) and perhaps informative. Here's the link: The Equation of Exchange.


Posted by: Professor C - 23 Jan 2010 - 10:47:01

Thanks for clearing up the confusion. does not have much in the way of explaining aggregate demand or the overall price level, so my understanding of these topics is pretty limited.
I'll be sure to check out the video.

Posted by: Alex Wheeler-s Friend - 23 Jan 2010 - 17:00:45

Good evening, Mr. Wheeler.

I must caution you that is run by Right-wing interests; its content is, therefore, every bit as reliable for objectivity as a Leftist rag.

Read as you wish, Mr. Wheeler; after doing so, think for yourself.

Posted by: Professor C - 23 Jan 2010 - 18:18:22

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