ECONOMICS Flashcards
how does hyperinflation help ge the nation out of debt?
What Is Hyperinflation?
Hyperinflation is when prices rise very, very quickly. Imagine if the cost of a pizza doubled every day—it’d be hard to keep up!
In real life, hyperinflation happens when a country’s money loses value super fast. People need more and more money to buy the same things.
How Does It Affect Debt?
When a government has debt (like owing money to others), hyperinflation can actually help.
Here’s how: Let’s say the government borrowed $1,000. But due to hyperinflation, prices skyrocketed. Now, that same $1,000 isn’t worth as much—it’s like paying back less in real terms.
Soft Default and Real Debt:
Hyperinflation acts like a “soft default.” Instead of saying, “We can’t pay our debt,” the government lets inflation reduce the real value of the debt.
So, even though they still owe the same amount in dollars, it’s worth less because prices went up.
Investment and Capital:
Less real debt encourages investment. When debt shrinks (thanks to inflation), there’s more room for other things, like businesses growing.
Higher inflation also means higher taxes on investments, which can discourage people from saving money. So, it’s a balance.
The Catch:
Hyperinflation isn’t a magic solution. If it goes too far, it hurts the economy. Imagine that pizza now costing a million dollars!
So, while some inflation helps, too much can cause chaos.
Remember, it’s like walking a tightrope—some inflation can help, but too much can lead to trouble!
What is “Monetary Policy”?
Monetary Policy is the decisions made by a governent concerning the money supply and interst rates. In the U.S. the Federal Reserve determines and implemets monetary policy
In order to understand monetary policy, you must first understand the relationship between money supply and banking in market economy. You will see that the **Federal Reserve **can affect the money supply through its policies.
How does the Fed affect the supply of money in the economy?
The Fed can affect the supply of money in the economy by changing the amount of money that banks must hold in reserves. It can use 3 different tools to do this: (1) change Reserve Requirements, (2) change the discount Rate, and (3) open market operations.
The Fed can affect the supply of money in the economy by changing the amount of money that banks must hold in reserves. It can use 3 different tools to do this: (1) change Reserve Requirements. What does this mean?
- Changing the Reserve Requirements:
If the Fed requires more (rasises) the amount of bank reserve requirements, there is less money available for banks to lend because they must keep more in reserves.
However, if the Feds want to expand the money supply in the economy, they can lower reserve requirements, which means there will be more money available for banks to lend.
Let’s think of the bank as a big jar of cookies. The cookies represent money.
When the Fed Raises Reserve Requirements:
Imagine the Fed (which is like the boss of all banks) tells the bank, “You need to keep more cookies in the jar and can’t give out as many.”
This means the bank has to save more cookies and can give out fewer cookies to people who want to borrow them.
So, there’s less money for people to use because more of it is sitting in the bank’s jar.
When the Fed Lowers Reserve Requirements:
Now, if the Fed says, “You can keep fewer cookies in the jar and give out more,” the bank doesn’t have to save as many cookies.
This means the bank can give out more cookies to people who want to borrow them.
So, there’s more money for people to use because more of it is being lent out by the bank.
In simple terms, raising reserve requirements means banks have to hold onto more money, so they lend out less. Lowering reserve requirements means banks can hold onto less money, so they lend out more. This helps control how much money is available in the economy.
The Fed can affect the supply of money in the economy by changing the amount of money that banks must hold in reserves. It can use 3 different tools to do this: **(1) change Reserve Requirements, (2) change the discount Rate.
What does it mean to change the discount rate?
(2) Change the Discont Rate: Discount Rate is the interst rate that it give to banks when they borrow money from the Fed, in the short term, to meet minimum rserve requirements.
So if the Fed charges ahigh interest rate, banks will be less likely to borrow from the Fed.
However, if the Fed charges a low interest rate, then banks may be willing to borrow, which means that they may make more loans.
Explain the Discount Rate:
What is the Discount Rate?
Think of the discount rate as the interest rate the Fed charges banks when they borrow money from the Fed.
It’s like when you borrow money from your friend, and they ask you to pay back a little extra. That extra is the interest.
When the Fed Raises the Discount Rate:
Imagine the Fed tells banks, “If you borrow money from us, you have to pay back even more extra.”
This makes borrowing from the Fed more expensive for banks.
So, banks might borrow less money from the Fed because it costs more.
As a result, banks have less money to lend to people and businesses, which means there’s less money in the economy.
When the Fed Lowers the Discount Rate:
Now, if the Fed tells banks, “If you borrow money from us, you don’t have to pay back as much extra.”
This makes borrowing from the Fed cheaper for banks.
So, banks might borrow more money from the Fed because it costs less.
As a result, banks have more money to lend to people and businesses, which means there’s more money in the economy.
In simple terms, changing the discount rate means the Fed can make it more or less expensive for banks to borrow money. This affects how much money banks can lend out, which in turn affects the amount of money in the economy.
The Fed can affect the supply of money in the economy by changing the amount of money that banks must hold in reserves. It can use 3 different tools to do this: (1) change Reserve Requirements, (2) change the discount Rate, and (3) open market operations.
What does it mean to “open martket operations”?
(3) Open Market Operations: Open Market Operations is where the Fed buys or sells government securities, such as treasury bills, treasury notes, and treasury bonds, on the open market.
If the Fed buys and increasing the circulation of money in the economy because it is trading dollars for the securities;
On the other hand, if the Fed sells securities, it is decreasing the money supply becasuse it is sucking-up (taking in) money in the economy and giving out Federal securities.
Open-Market operation is the tool used the most in recent years.
Is the discount rate the most important interest rate for the wider economy?
No. The Discount Rate is not the most important interest rate for the wider economy. (Banks generally don’t borrow from banks when they are short on reserves. Banks borrow from eath other.) The interest rate that banks borrow from each other is known as the Federal Funds Rate. Banks also get money from Deposits.
Are most other interest rates are based on the Federal Funds Rate?
Changes in the Federal Funds Rate have large influence on interst rates. The Feds have no direct means of changing the federal funds rate. (However, the Fed still can get what it wants: If the Fed announces that it has a target goal – 25% drop, for example – it will indeed drop a quarter point – 25% drop. The fed can make this happen throgh Open Market Opertions.
What happens if the supply of money increases?
If the supply of money increases, inbterest rates go down because banks compete to win borrowers.
On the other hand, if the supply of money decreases, interest rates tend to increase. Remember: The Fed can buy Federal securities to increase the money supply; and sell federal securities to decrease, the money supply.
A reduction in money supply will do what to the interest rates?
A reduction in money supply will increase interest rates.
An Increase in Money Supply will do what to the interest rates?
An increase in Money Supply will Decrease interest rates.
