Economics Questions

Re: A question from a friend

robertp — Thu, 24 Jan 2008 20:20:20 GMT

The interest rate is set by the supply and demand bidding process just like everything else. There is a supply of savings and a demand for investment. The price of savings, the price of investment and the interest rate are all the same thing. The fed cuts rates by buying securities with "checkbook money" or "ink money" or "money printed out of thin air" until the interest rates goes down to the targeted amount.

One thing to realize is that when you "print money" investment increases while saving decreases, Uh Oh. Keep learning about Austrian economics to learn all the effects that can cause...

Fractional reserve banking can also "create money out of thin air". When you put your money into a demand deposit, you have a claim on all those dollars, they're YOUR dollars. The bank will lend those dollars out, and a creditor will have a claim on those same dollars, they're also HIS dollars. Now that 2 people claim the same dollar, you've "created money out of thin air". This process is inherently unstable, if you try to get all your dollars out at once, the bank won't have them. One thing the fed does is lower the interest rates("prints money") when banks have "liquidity problems"(they don't have your money and you want it back), this acts as a "moral hazard" and facilitates more lending of demand deposits than would happen without the fed, AKA more creation of money.

Re: A question from a friend

macsnafu — Wed, 23 Jan 2008 20:15:11 GMT

Meistro:

"So I understand that when the Fed cuts rates, it creates "cheap" credit. However, can someone explain to me (using simple language that I could replicate for other non-Econ majors) precisely how the availabilty of this cheap credit leads to the increased creation of money "out off thin air"? Thanks :-)"

The Fed cuts rates by increasing the money supply and making this new money available for loans at lower rates. It is because they are using newly printed money that the Fed is not constrained by the market rate of interest.

Re: A question from a friend

Stranger — Wed, 23 Jan 2008 19:38:42 GMT

I meant that the central bank exists in order to prevent the belief in credit money from collapsing.

Re: A question from a friend

Solredime — Wed, 23 Jan 2008 19:04:42 GMT

Stranger:
Longer answer: Their demand for money is supplied by credit. When that belief collapses you see a bank run. The central banking system exists to prevent this from happening.

Minor correction, the central banking system does not prevent bank runs from occuring, but rather it supplies enough money out of thin air to hand out to these people when the bank run does occur. (see Northern Rock and the UK Government's £54 billion "emergency funds"

Re: A question from a friend

Stranger — Wed, 23 Jan 2008 18:34:41 GMT

The credit is money. People believe, rightly or wrongly, that everything in their checking account corresponds to an actual dollar.

Longer answer: Their demand for money is supplied by credit. When that belief collapses you see a bank run. The central banking system exists to prevent this from happening.

A question from a friend

Meistro — Wed, 23 Jan 2008 06:58:50 GMT

"So I understand that when the Fed cuts rates, it creates "cheap" credit. However, can someone explain to me (using simple language that I could replicate for other non-Econ majors) precisely how the availabilty of this cheap credit leads to the increased creation of money "out off thin air"? Thanks :-)"

Ideally an explanation would be in laymen's terms.