Page 623 - The Principle of Economics

CHAPTER 28 MONEY GROWTH AND INFLATION 639
IN THE NEWS
Russia Turns to the Inflation Tax
WHENEVER GOVERNMENTS FIND THEM- selves short of cash, they are tempted to solve the problem simply by printing some more. In 1998, Russian policy- makers found this temptation hard to resist, and the inflation rate rose to more than 100 percent per year.
Russia’s New Leaders Plan to Pay Debts by Printing Money
BY MICHAEL WINES MOSCOW—Russia’s new Communist- influenced Government indicated today that it plans to satisfy old debts and bail out old friends by printing new rubles, a decision that drew a swift and strong re- action from President Boris N. Yeltsin’s
old capitalist allies.
The deputy head of the central bank
said today that the bank intends to bail out many of the nation’s bankrupt finan- cial institutions by buying back their multibillion-ruble portfolios of Govern- ment bonds and Treasury bills. The Gov- ernment temporarily froze $40 billion worth of notes when the fiscal crisis erupted last month because it lacked
the money to pay investors who hold them.
Asked by the Reuters news service how the near-broke Government would find the money to pay off the banks, the deputy, Andrei Kozlov, replied, “Emissions, of course, emissions.” “Emissions” is a euphemism for printing money.
Hours later in Washington, Deputy Treasury Secretary Lawrence H. Sum- mers told a House subcommittee that Russia was heading toward a return of the four-digit inflation rates that sav- aged consumers and almost toppled Mr. Yeltsin’s Government in 1993.
Russia’s new leaders cannot repeal “basic economic laws,” he said.
SOURCE: The New York Times, September 18, 1998, p. A3.
massive inflation. The inflation ends when the government institutes fiscal reforms—such as cuts in government spending—that eliminate the need for the inflation tax.
THE FISHER EFFECT
According to the principle of monetary neutrality, an increase in the rate of money growth raises the rate of inflation but does not affect any real variable. An impor- tant application of this principle concerns the effect of money on interest rates. In- terest rates are important variables for macroeconomists to understand because they link the economy of the present and the economy of the future through their effects on saving and investment.
To understand the relationship between money, inflation, and interest rates, recall from Chapter 23 the distinction between the nominal interest rate and the real interest rate. The nominal interest rate is the interest rate you hear about at your bank. If you have a savings account, for instance, the nominal interest rate tells you how fast the number of dollars in your account will rise over time. The real interest rate corrects the nominal interest rate for the effect of inflation in order to tell you how fast the purchasing power of your savings account will rise over time. The real interest rate is the nominal interest rate minus the inflation rate:
Real interest rate 􏰀 Nominal interest rate 􏰂 Inflation rate.