Forgive my ignorance.
I have begun reading more about ABC theory and would really like to have certain concepts clarified/explained to me.
What I would like to know pertains to the mechanism/process whereby artificially low interest rates create monetary inflation.
Is it purely the result of loans/credit expansion? In this case, primarily who receives such loans and how does new money work its way through the economy to eventually cause a rise in prices? Why do low interest rates necessarily create an expansion in the monetary base?
Don't be surprised if I ask more questions about this after reading some answers.
What's the question?
Rcder: What's the question?
Sorry, my post was not working. My
Joe Salerno:
...the Fed does not directly set interest rates. This is the great modern myth, which was designed to conceal the Fed's true modus operandi. The Fed influences interest rates by creating and injecting dollar reserves into the banking system. The additional reserves increase the supply of loanable funds relative to the economy's demand and thus induce banks to offer loans at lower interest rates in order to attract borrowers for the additional funds. So causation runs from the increase in Fed–created base money to reduced interest rates. Lower interest rates are just one of the distortions caused by the Fed's unrestrained power to create money ex nihilo.
In simple English, it's not low interest rates that cause monetary inflation, just the opposite. It's printing money [paper or digital] that makes the interest rates go down.
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That really clears up a lot, thanks.
Some further questions:
1) How does this money end up in the banks? Do the banks always willingly accept new base money from the Fed? (I realise the question seems naive)
2) What happens to the newly created money - how does it move through the economy, and how does this movement through the economy, in turn, affect prices?
3) From what I understand, Hayek explained that those who benefitted from credit expansion ended up competing for resources (monetary, I suppose?) which bid up the cost of their investments, thereby revealing these investments to be malinvestments. Any explanations or further reading that will explain exactly what he said, and how this worked?
General info: http://library.mises.org/books/Henry%20Hazlitt/Economics%20in%20One%20Lesson.pdf
Big picture about govt's and central banks: http://library.mises.org/books/Murray%20N%20Rothbard/What%20Has%20Government%20Done%20to%20Our%20Money.pdf
How the Fed works: http://mises.org/media/4390/Money-Banking-and-the-Federal-Reserve?ajaxsrc=video
1. The Fed buys assets they banks own at very profitable [for the banks] prices, aka making an offer the banks cannot refuse. It pays for what it buys from the banks with newly printed paper or digital money.
2. The banks lend the money either to businesses or to the govt, and they spend it. By the law of supoply and demand, the greater the demand for what the businesses or the govt buys [and there is greater demand because there is more money available to buy the stuff now], the higher the price. Those who sold stuff to the businesses or the govt now have more money at their disposal, increasing their ability to demand, thus increasing the prices of whatever they will be buying. And so the money passes from hand to hand, raising prices as it goes.
3. This is a bit of an advanced subject, called the Austrian Business Cycle Theory. I don't know which is the best introductory book or article or video to this fascinating subject. Look around in JJ's mighty lists.
Thanks very much! one last question, if I may (sorry for being a pest):
i understand that bank loans are extended to large institutions (government, businesses). However, I would imagine that they are more likely to spend money on things other than consumer goods (such as producer goods, or bailouts in the case of government.). How, then, are ordinary consumer goods prices (for things as basic as bread) increase? Is it because producers' costs go up as businesses compete for resources and bid their prices up? Please explain this last problem to me.
Is it because producers' costs go up as businesses compete for resources and bid their prices up?
That's one reason. Also see point 2 in earlier post, about the money changing hands on and on, with each new recipient hiking up the price of what he buys. Eventually it gets to the folks who buy bread.