Inflation and Deflation
- Money works best as a store of value, a unit of account, and a medium of exchange.
- When inflation occurs, money loses value.
- When deflation occurs, wages, goods, and profits fall while debt stays the same.
- Commodity money solves hyper inflation because:
- No government can produce new quantities of gold, etc.
- However, governments can manipulate money to help the economy during economic downturns (by printing stimulus checks, etc).
- The value of money depends on its supply relative to the supply of other goods.
- You can't increase collective wealth without increasing the stock of things that hold true value.
- If GDP and money supply grow at the same rate, prices will remain stable.
- Inflation punishes savers.
- Falling interest rates can help improve economic downturns. Example, people purchase more real-estate.
- Money Illusion: People are happier if they receive a 1% raise even when inflation rises 2% compared to a 1% pay cut paired with a 1% increase in inflation.
Credits and Crashes
- Banks borrow "short" and lend "long"
- If a high proportion of depositors (or other investors) suddenly want their money back, this will cause a crash. The reason is because these funds are likely tied up in other investments and can't be easily converted into cash.
Exchange Rates and the Global Financial System
- When a country's currency rises, exports fall (vice versa).
- Money supply decreases, interest rates rise because capital becomes more scarce.
- Gold standard has two important strengths. It precludes hyperinflation, as the quantity of money is constrained by the quantity of gold. If adopted across countries, a gold standard fixes exchange rates in a predictable way.