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Notes -
Here's everything I know about macro:
Inflation is defined as an increase in the general price level.
The price of something is determined by the ratio between the value of a dollar and the value of that thing. (?)
The value of a dollar comes from, er, somewhere? You need dollars to pay taxes? Everyone else wants dollars so you want them to trade them with those suckers who want them? Something about oil?
The government can "dilute" those dollars by printing more, in effect taking value from everyone who holds dollars, or "concentrate" dollars by destroying them?
Fractional reserve banking, de facto, means that when you take a loan the dollars are minted and when you repay a loan the dollars are destroyed. The government can increase the supply of loans by lowering the reserve ratio or their discount rate, and increasing the supply of loans means more loans are taken, which means more dollars are created, so they can "create" dollars by increasing the supply of loans or destroy dollars by decreasing the supply of loans.
The government can also borrow money, but I have no idea about the effects are of government borrowing so I'm going to ignore it
When there's inflation, the profit-maximizing behavior is to raise prices. When there's deflation, the profit-maximizing behavior is to lower prices
People are irrationally unwilling to lower their prices, so deflation leads to people making less profit, which makes them worse off, so the government really wants to prevent deflation and will tolerate some inflation if that's what it takes
Everyone knows the government can't make sure inflation is 0, so instead they try to make inflation be about 2%, so even if they mess up and miss that goal by a little at least it's better than deflation.
That all makes sense so far.
It seems like a problem is that inflation has some "lag". The prices go up at the store before the price of my labor goes up. So for a while, my purchasing power goes down. I suspect that the reason that deflation intuitively sounds like such a good deal is that people assume that the lag will exist there too, so people's purchasing power will go up for a bit.
If the fed came to me and asked "hey, we need to print more dollars and get them out there with as little lag as possible, what should we do?", the first approach that would come to mind would be to print a bunch of money and give it to everyone equally.
But there's an asymmetry: you can give dollars to everyone and most people won't complain, especially if it's for a worthy cause like preventing deflation which would cause a recession. But you can't as easily take the dollars away from everyone equally because some people might not have any for you to take. (You could indebt those people, but that intuitively seems like a pretty bad idea to me.)
So I've been playing with another idea: Make a federal bank account, and when you want to change the supply of money, multiply the balances of everyone's federal bank accounts by some constant. (If they think you're going to multiply their bank accounts by a number less than one, they'll take their money out, but hopefully if you're doing a good job at being a central bank no one will know in advance what you're going to do, because these decisions will be made by a subsidized prediction market and to predict its movements you'd have to violate EMH, and anyone who can violate EMH that has better things to do than take their dollars out of their federal bank account.)
Consider the case where the fed wants to create inflation:
The current way privileges people who take loans. Since people who take big loans tend to have good credit, and people who have good credit tend to be wealthier than average, the current system kind of a transfer to the wealthier than average. Meanwhile, my suggestion would privilege people who keep their cash in the federal bank account. Poor people keep a larger percent of their net worth in cash, so my proposal would be a transfer to the poor.
Consider the case where the fed wants to create deflation:
The current way has the desirable property that poor people (who don't take many loans) are basically unaffected. But it has the undesirable property that the reduction in the supply of money is gradual at some level, because it works by people repaying loans and then not taking new ones. But it's also not gradual at another level, because having the option of taking a loan in the future might make you more spendy in the present (knowing you could get a loan is a kind of asset). Also, EMH says it doesn't matter how gradual it is, because if everyone knows the value of money is going to change tomorrow they're going to act like it's tomorrow's value today. Let's call this one a wash.
I'm mostly just posting this because I think macro is fun to talk about and this thought experiment has been good at getting me thinking about it. Plus I didn't want my first post to be about some degen CW twitter controversy. Anyone have any thoughts?
#2 is incorrect. Prices of a thing are a function of supply and demand, not the value of the thing and the value of a dollar. First, things do not have values; they have prices. Eg: Gasoline prices, after all, go up and down even as the value remains constant. Perceived value can affect demand (which is the willingness and ability to buy different amounts of a product at different prices, so it can affect willingness, but really that is just part of utility. Second, the "value of a dollar" doesn't mean much: it is a vernacular term commonly used to refer to prices; saying "the value of the dollar has shrunk since I was a kid" is simply a way of saying that prices have gone up. Changing the supply of money does affect prices, including the price of borrowing money (ie, interest rates), but its effect on consumer prices is really more about its effect on aggregate demand (see #4)
#3 is irrelevant, per above. The price of a dollar relative to other currencies is a function of supply and demand for each currency, which in part is a function of trade imbalances.
#4, since currency is only about 10 percent of the money supply, the government rarely prints money in order to adjust the money supply. Rather. the fed tries to affect inflation by adjusting interest rates, changing bank reserve requirements, and buying and selling bonds. Total demand in an economy consists of 1) consumer demand; 2) business demand; 3) government demand (expenditures - income); and 4) Net foreign demand (exports - imports). When the Fed raises interest rates it charges banks, banks borrow less from the Fed and hence loan less to businesses, thereby reducing business demand. Also, banks charge higher interest on loans (there is a lower supply of money available to lend, so the price of a loan -- the interest rate -- rises). When the Fed buys outstanding bonds, there is more money in the hands of consumers or businesses (whomever held the bonds), so demand rises. To reduce demand, the Fed tries to sell more bonds. Bank reserve requirements are discussed below.
#5: Suppose a bunch of us go to Mars. I am the only one with money ($10,000 in cash). Money supply is now $10,000. I deposit it into your bank and open a business. Since the business is not drug dealing, I pay my suppliers by check, not in cash. So, I open a checking account. You are a bank. You make money by lending it out. Suppose you lend $9000 to Joe to start his business. He does not want cash; rather you open a checking account for Joe, and write "$9,000" in his account ledger. Joe now can write checks up to $9,000, and I can write checks up to $10,000, so the money supply is now $19,000. That is how fractional reserve banking affects the money supply. Changing the reserve requirement or otherwise discouraging or encouraging lending changes how big that part of the money supply is.
#6 - See discussion of bonds above. If govt borrows money to spend it, not much happens: Consumer/business demand drops, but govt demand rises. If govt borrows money and sits on it, then aggregate demand declines.
#8 - The govt wants to avoid deflation because it creates the risk of recession; When there is deflation, rational consumers delay big ticket purchases in hopes of paying less in the future. That reduces demand, leading to layoffs, which leads to more reduced demand and even more deflation, and the process accelerates.
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