Economics Questions

Re: The process by which monetary inflation causes rising prices

Esuric — Mon, 20 Jul 2009 20:51:42 GMT

JohnNada:
As far as I understand, the reason artificially inflating the money supply causes this, is because, since all this new credit is loaned out at interest, the business owners and individuals who took out these loans are forced to charge more for their goods and services, in order to cover the interest. This sets into motion a long term domino effect for the rest of the economy, resulting in a higher cost of living in general.

No, expanding the money supply through credit inflation presupposes an artificial drop in interest rates; this is why lowering interest rates is seen as a "stimulus." They are able to charge higher prices because they can, because there's more money in the economy and ultimately in people's hands. The FED opens accounts for commercial banks; those banks hold a certain percentage of the money given to them, around 10%. They lend out the rest, continuously, in cyclical phases. The newly created "dollars" are given to investors/businesses/corporations, who start investing in stupid shit, i.e., Coldstone, Starbucks. The fractional reserve system works like this:

1) Fed opens account for commercial bank for $100, that bank has to hold $10, and lends out $90.

2) They then receive the $90 back, hold $9, and lend $81.

3) Hold $8, lend $73.

4) Hold $7.3, lend 65.7

5) Hold $6.57, lend $59.13

So on and so forth, there's a multiplying effect. The explanation of why prices and wages increase in nominal terms is very technical, but essentially, the economy goes on an unsustainable boom where firms are made profitable by perpetual inflation, and a constant reduction in interest rates; but once this inflation stops, there's a correction (recession). The inflation must stop because banks over-leverage themselves, and in fear of panic, they recapitalize, leading to a credit crunch and deflation.

Re: The process by which monetary inflation causes rising prices

nirgrahamUK — Mon, 20 Jul 2009 20:47:43 GMT

http://mises.org/story/2914

Let us see what happens under inflation, and why it happens. When the supply of money is increased, people have more money to offer for goods. If the supply of goods does not increase — or does not increase as much as the supply of money — then the prices of goods will go up. Each individual dollar becomes less valuable because there are more dollars. Therefore more of them will be offered against, say, a pair of shoes or a hundred bushels of wheat than before. A "price" is an exchange ratio between a dollar and a unit of goods. When people have more dollars, they value each dollar less. Goods then rise in price, not because goods are scarcer than before, but because dollars are more abundant.

-Hazlitt

Re: The process by which monetary inflation causes rising prices

JohnNada — Mon, 20 Jul 2009 20:29:38 GMT

I can understand it on a conceptual, macrocosmic level. I'm just trying to understand it on a more practical, microcosmic level. I.e. The step-by-step causal chain - starting with the initial inflation of the money supply - of individual economic interactions that collectively result in a higher general cost of living.

Re: The process by which monetary inflation causes rising prices

Stephen — Mon, 20 Jul 2009 20:24:45 GMT

It simply follow from the law of marginal utility that additional units of an equally serviceable supply of a good will result in the actors placing a lower value the marginal unit and the fact that money is the most commonly accepted medium of exchange, that the ratio of exchange of other goods to money will rise as additional units of money are created.

Re: The process by which monetary inflation causes rising prices

DanielMuff — Mon, 20 Jul 2009 20:14:58 GMT

See this: Money, Banking and the Federal Reserve http://www.youtube.com/watch?v=iYZM58dulPE

Re: The process by which monetary inflation causes rising prices

nirgrahamUK — Mon, 20 Jul 2009 20:14:27 GMT

the way to understand why money supply inflation leads to a higher price level is to do the thought experiment of what if when i awoke tomorrow, the productive capacity of the economy hasnt changed but everyone has double the quantity of money in their possession.

The process by which monetary inflation causes rising prices

JohnNada — Mon, 20 Jul 2009 19:54:23 GMT

Hi everybody.

I'm currently making a documentary that will feature a twenty minute segment on the history and practice of Fractional Reserve Banking. My goal is to condense this vast, sometimes complicated subject into an easy to understand presentation, that the average person will hopefully understand. I aim to use layman's terms and palatable, easy-to-relate-to examples to explain how our banking system evolved from the fraudulent money-creation practices of 16th/17th century European goldsmiths, into what it is today.

My goal is to demonstate how concepts like monetary inflation (As opposed to price inflation, which is the result of monetary inflation) work, and how the redistribution of wealth, from the general public into the hands of the money creators/lenders, is inherent to the system.

I'm aware that when the money supply grows faster than the total output of goods and services, after an initial economic boom, prices go up. As far as I understand, the reason artificially inflating the money supply causes this, is because, since all this new credit is loaned out at interest, the business owners and individuals who took out these loans are forced to charge more for their goods and services, in order to cover the interest. This sets into motion a long term domino effect for the rest of the economy, resulting in a higher cost of living in general.

I'd be extremely appreciative if any of you can clarify for me whether my understanding is accurate or not, and―if it's not―if you could explain to me in as straightforward language as possible, the process by which rising prices occur. Ideally I'd like to be able to explain this to people on a step-by-step basis; From the initial creation of artificial money as debt, to the succession of individual interactions that inevitably cause the cost of living to rise in the long term.

Thanks in advance!