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Transcript of macro
(Fiscal Policies) The Fed = Monetary Policy Currency Valuation Depends On: Currency Depreciation Budget Deficit (if Government spends more than it has the currency becomes unattractive)
Trade Balance (same concept of soundness)
Interest Rates (the more one gets paid to hold bonds in a currency, the more attractive it becomes). Currency Depreciation Leads to Inflation Presumably transitory and delayed
First increase in price foreign products
Leading to increased demand domestic products
And finally, a general increase in prices. In the end governments HAVE TO increase INTEREST RATES.
Not immediately, though, because: If inflation gets bad... Increased rates make borrowing $ for business more expensive, decreasing hiring (unemployment), and discouraging spending (e.g. people don't apply for mortgages), which leads to lower GDP.
(Fed) buying government debt to increase monetary base (direct route to inflation), or simply to prevent the government from having to pay extraordinary INTEREST RATES (more on this later - open market)
Fed can devalue $ to promote exports and, indirectly, employment and GDP by "injecting" $'s in foreign banks, or purchasing foreign currencies. Effects on inflation not so negligible if monetary easing also going on: Open Market Governments can borrow in the open market
However, lenders can be fickle
When it's time to roll over the debt they can go on a "lending strike."
It's the "bond vigilante" fear
The Chinese have been enabling the U.S. government spending spree
Also other creditors in a "flight to safety" because of the problems in Europe. Sometimes it's not up to the government to decide to increase interest rates. If the central bank can't tweak the rates by buying debt from the government
(e.g. Greece, Italy or Spain 2012, at the mercy of the German ECB) the financing depends on the whims of the... Some Like Inflation It allows the NOMINAL GDP to be higher every year.
It discourages SAVINGS
It encourages SPENDING
It encourages INVESTING - cheap money to start factories or projects
KEY CONCEPT: COST OF BORROWING = % interest rates - % inflation - the more inflation, the less the cost of borrowing. Since unions renegotiate wages every year, it takes a long time before it affects workers.
So politicians keep their voters and get to continue spending.
And entrepreneurs may like it too - easy credit. Who loses? At first savers and professionals without adjustable salaries.
Eventually everybody when INTEREST RATES eventually go up. Or the increases in wages lag behind accelerating inflation (Weimar hyperinflation 1922 - 23). In the end... Fiscal stimulus and monetary easing are tricky ways of keeping employment and GDP growing. Inflation (too much paper money in the system) or currency depreciation (leading to loss of interest in financing debt on the part of investors) can become issues requiring painful increases in INTEREST RATES. Isn't this what savers wanted all along? What savers? By the time the government raises INTEREST RATES, inflation has long been roaring, and their savings are wiped out - unless, of course, the government and central banks are reined in from outside (open market) as in Europe.
There the pain comes from necessary HIGHER TAXES (to pay the government debt and appease investors); and from LOWER WAGES (increased productivity and consequent increased competitivity with other economies, obtained without the more common currency tricks - not allowed by the ECB). Inflation Gold Standard? Forces DEFLATION occasionally
More often than not as a consequence of first leaving the gold standard during a war, and then resuming the gold standard pegging it to prewar values.
But it will happen - when prices go up to a certain point, the demand for gold-backed currency will increase, and the value of each unit of this inelastic currency will increase, leading, ultimately, to a decrease in prices: autorregulation.
Why is DEFLATION so bad? It's not bad for savers, whose assets in gold-convertible units will increase in value, while prices go down. But it will affect people in debt (whatever $ figure they owe will be more difficult to pay with time); companies will also be less prone to dump appreciating money into projects, decreasing employment; and this problem will be compounded by the lack of demand for products.
So governments tend to favor the blue-color worker, whose salary may be adjusted or renegotiated by the union, to keep up with the government imposed level of inflation. The inflicted inflation makes mortgages more affordable, and promotes investments by companies, and consumption by individuals. The GDP (nominal GDP - not inflation adjusted) grows, and the government can spend more (keeping government expenditures fixed, as a fraction of the GDP).
The loser in the game is the pensionist on a fixed income, the saver and wealthy, or the professional whose salary is not scalable. The government adheres in the end to the robotic Sarah Palin pronouncement that money is supposed to decay with time. Perhaps Bush & Reagan increased the $ supply, but check this graph...