Money and prices relationship help

Money supply and demand impacting interest rates (video) | Khan Academy

money and prices relationship help

We study the relationship between money and prices in Argentina for the . Granger causality test are performed to see if changes in one variable help to predict. This article explains the money side of prices, and why government currencies have a full understanding of the relationship between money and goods. .. Quantitative easing to support asset prices and to fund government. The Relationship Between Money and Prices: Some Historical .. Calomiris ( ) discusses the lack of support for the quantity theory in these historical.

The way it's done in the US Fed, most part they go out and buy government securities which is essentially lending money to the Federal Government. They do that because that's considered to be the safest investment. They go out there and they lend money. If this is our original supply curve. If this is our original supply curve, but now your Federal Central Bank is printing more money and lending it out.

What is going to happen over here? Your supply curve is going to shift to the right at any given price, at any given interest rate. Your going to have a larger quantity of money being available. It might look something like Assuming that's the only change that happens you see its effect.

money and prices relationship help

Your new equilibrium price of money, the rent on money, or the interest rate on money is now lower. That's why when the Federal Reserves say I want to lower interest rates, they do so by printing money. They print that money, and they lend it out in the market.

That essentially has the effect of lowering interest rates. Let's think about another situation. Let's say this is the Fed prints and lends money. Their lending the money by buying government bonds.

The Intertemporal Relation Between Money and Prices: Evidence from Argentina

When you buy a government bond, your essentially lending that money to the Federal Government. I've done other videos on that where we go into a little bit more detail on that. Let's think of another situation. Let's think about consumer savings go down. One interesting thing about savings, savings and investment are two opposite sides of the same coin. When you save money You have the whole financial system right over here. This is the finincial system. That money goes out and is lent to other people.

For the most part, hopefully, that money when it's lent is used to invest in someway. If consumer savings goes down that means the supply of money will be shifted to the left. At any given price and any given interest rate their be less money available. In this situation our supply curve is shifting to the left. That would increase interest rates. Then you could even make an argument that if consumers savings is going down consumers are going to borrow less as well.

You could argue that maybe demand would go up as well. Your demand could go up and that would make the equilibrium interest rate even even higher.

money and prices relationship help

Let's do another scenario. Let's say that the Federal Government in an effort to The government decides to borrow a lot more money. The government is essentially going expand it's deficit. The government is going to borrow money. Here our supply isn't changing. I'm assuming the Central Bank isn't changing it's policies, how much it's printing. Savings rates aren't changing. The demand is going to go up.

Government is borrowing money.

Value of Money and the Price Level (With Diagram)

The government is going to borrow more money than it was already doing. There is an important difference between the money we use today and the sound money of yesteryear. All money not freely convertible at a fixed rate into gold is credit money. Even cash notes and coins are government credit, while customer deposits in the banks are unmistakably credit in both origin and fact. The quantities of government credit-money and bank-credit money can and do vary considerably.

Gold as sound money varies less so, due to its inflexible nature. Gold is continually mined, and the quantity allocated to money also varies as the proportion of the above-ground stocks assigned to other uses fluctuates, such as for jewellery and ornamentation. The human population has increased, particularly over the last two centuries, so there are more people on earth requiring monetary liquidity, and as their living standards improve, their aggregate demand for monetary liquidity is bound to increase as well.

Together, these factors lead to a continuing increase in the purchasing power of gold over time, when it is used as money. Even though today it does not circulate as money, this is still true.

Money supply and demand impacting interest rates

Gold matters, because, excepting silver, it is the only form of money that has survived since individuals discovered the convenience of money over barter. It is also beyond the control of governments, as they cannot issue it without acquiring it first. It is subject to the constraints of its quantity, so that as a medium of credit it cannot be debauched, only defaulted upon. Its relative inflexibility and its soundness are the primary reasons governments do not like monetary gold, and force their preferred alternatives on their citizenry.

The vested interest of governments is therefore to discourage, or even ban the use of gold as competing money. The educated people, who are the readers searching for an understanding of prices by reading Keynesian and monetarist-inspired journals and papers, are the ones who have lost their monetary compass entirely.

This is all of us in the welfare states, educated but ignorant about the theory of money, literate but woefully uninformed about the true relationship between money and goods, believing money is a matter for the state. It is us who do not understand the dangers of fiat money issued by the banking system in increasing quantities.

Understanding the objective exchange value of money The purchasing power of money in a general sense is regarded as its objective exchange value.

Money is the anchor in a transaction, and contrasts with the subjective value placed on goods. As users of money, it is convenient for us to assume there are no price changes from the money side, so that all subjectivity in pricing is reflected in the goods being exchanged for it.

When we render financial accounts, this assumption carries through, as it does in law as well. However, we are generally aware that over time, if not during our daily lives, the value of money is far from being an objective constant. This raises the question as to on what grounds we base our value of money.

Logically, we can only know the value of money by referring to our most recent experience of its value, and then incrementally back in time, that we might judge its soundness. This is the reason a resident in Switzerland is likely to have a different appreciation of his francs, compared with a resident in Argentina of his pesos. Paper and digital money have no alternative use-value. To gain credibility, the longer-lived government currencies of today based their integrity on gold or silver, being at one time freely exchangeable into one or other of these monetary metals.

This is no longer the case, which from a theoretical standpoint, places government currencies at a continual risk of losing their credibility as money altogether. This is not an acceptable refutation of the regression theorem described in the paragraphs above, and it is the duty of an economist seeking the truth not to duck this important issue. Without understanding the relationship between money and goods, errors of monetary policy are inevitable. And as those errors become manifest, the personal freedoms we enjoy between us, by exchanging goods at prices mutually agreed, become restricted through increasingly distortive and counterproductive government interventions.

money and prices relationship help

If total money and credit in an economy are constant over time, and assuming for a moment that the price-benefits of competition, improved manufacturing techniques and technology are put to one side, the general price level can only remain stable if the general preference for holding money relative to goods also remains constant.

Money quantities have soared Since the last financial crisis, there has been a massive expansion in the quantities of most currencies. The following chart shows the expansion of fiat dollars sincewhich has been far greater than the rate of increase prior to the financial crisis, shown by the dotted line. The fiat money quantity records the total amount of money both in circulation and in the banking system in the form of cash and ready deposits.

Without resorting to the evidence of questionable government statistics, it is easy to see that this tripling in money quantity in only nine years has not yet led to the expected increase in the general price level.

Part of the explanation is that monetary inflation has so far predominantly exaggerated asset prices. But any resident living in financial centres will attest that prices are indeed rising more rapidly than government statisticians admit. Far from being a mystery as to why prices have not yet reflected the rapid expansion of the quantity of money, price rises are indeed on their way, with much of the increases yet to come.

Since the financial crisis, monetary expansion has become the dominant factor in raising the general level of monetary preference. Bank deposits have become swollen as bank credit has been expanded, because it takes time for individuals to readjust their cash balances to their economic needs.

Remember, the purpose of money is to act as a bridge between our production and consumption, not as an asset to accumulate. The readjustment of money preferences back to normality is subject to a combination of factors, including the inflation of asset prices, before it affects prices of goods.

The suppression of interest rates continues to generate new deposits by encouraging the expansion of bank credit as well, as the chart above shows. Furthermore, the ownership of all that cash tends to start in a few hands, dispersing into wider ownership over time. However, the move towards a preference for goods, as people try to reduce their burgeoning cash balances, is never matched by an increase in their availability, leading to imports, trade deficits, currency weakness, and rising prices by that route.

This is the reason trade deficits are a consequence of the expansion of bank credit in the hands of consumers. Indeed, without a ready supply of goods from abroad, domestic prices would rise more rapidly as the balance of monetary preferences readjusts towards normality.

money and prices relationship help

There are, therefore, two routes through which prices can adjust to the change in monetary preferences for any given currency: When goods are imported, the price rises are often delayed by this roundabout route, and the fact that domestic supply bottlenecks are thereby temporarily alleviated. Otherwise the consequences are the same. Prices rise to accommodate the swing from money preference towards a preference for goods, instead of production being sustainably stimulated.

We must now address the problem on a global basis, because the supply of goods to an individual nation-state expanding the quantity of money relies to a large extent on imports. This cannot be the case when central banks are following the same expansionary policies on a coordinated basis, ignoring, for the purpose of our argument, differentials in savings rates.

The shortage of goods as money-preferences recede cannot be satisfied from another planet, so in aggregate, prices everywhere must rise rapidly to absorb the adjustment in relative preferences. We do not need to imagine it, because these are precisely the conditions we now face, thanks to the coordination of monetary policies on a global basis.

The rate at which the general price level rises is broadly set by the rate at which the preference for money deteriorates in favour of a preference for goods. The result is the total money stock relative to the total value of all goods reverts to where it was before the quantity of money expanded, but each monetary unit buys considerably less.

This in common parlance is hyperinflation, and a crack-up boom as people scramble for goods in a rush to dispose of money altogether. It may be easier to visualise this effect if the validity of objective exchange values for currencies is dispensed with entirely.

The evidence then becomes clear. Today, it is missed by nearly all commentary in the financial press, which focuses on the rapid expansion of debt, ignoring the simultaneous increase in the quantity of money.

Inflation and deflation The expressions inflation and deflation are too crude for a proper understanding of money and prices, particularly in the context in which they are commonly used.