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I'm an economic illiterate, so please help:

Assumption: Inflation is characterised by too much money chasing an amount of goods.
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Question: If to increase the supply of money, a government prints more, how does it reduce the supply of money? Do govts bonds soak it up (as the govt 'rents back' cahs)? Does the govt increase the liquid reserves banks have to have (seems slow method).

So how do you suddenly decrease the amount of money floating around? Or can you only make the amount relatively less by stimulating more goods to be available - ie an amount of money now chasing more goods so prices lower and inflation drops)

Whats a good basic book on economimcs for Australian society? Anyone know?

stumpjumper wrote:I'm an economic illiterate, so please help:

Assumption: Inflation is characterised by too much money chasing an amount of goods.
'
Question: If to increase the supply of money, a government prints more, how does it reduce the supply of money? Do govts bonds soak it up (as the govt 'rents back' cahs)? Does the govt increase the liquid reserves banks have to have (seems slow method).

So how do you suddenly decrease the amount of money floating around? Or can you only make the amount relatively less by stimulating more goods to be available - ie an amount of money now chasing more goods so prices lower and inflation drops)

Whats a good basic book on economimcs for Australian society? Anyone know?

The definition for inflation is close. It is caused by too much money chasing too few goods. The definition of money really needs to be defined better though. Money is not necessarily just the notes you carry around in your wallet. It is defined as being a medium that can be exchanged for goods and services and can be counted (a unit of account). During some wars items such as cigarettes were used as money.

There are a few ways excess cash can be removed (excess liquidity) and similarly a few ways it can be added. One of the most important is the job of the RBA, through open market operations. When there is an excess or shortage of cash they enter into repo transactions, usually with financial institutions. They will remove excess cash by purchasing the securities of whoever they are involved with in the transaction. The opposite occurs when there's a shortage. The RBA is independent of the government, and it's goal is to keep the consumer price index level of inflation over a longer term between 2-3%. The target cash rate it uses is a rather blunt way of controlling this level of inflation.

Here's a bit of a text book answer.

It's less to do with the supply of money, and more to do with the 'velocity of money,' that is, how often it changes hands. If the velocity is high, ie, people are spending and not saving, the prices of goods and services are bided up. If the velocity is low, and people park their money in the bank or under the mattress, then the amount of money chasing those goods and services drops, and the prices drop.

So, the question becomes, how do you discourage people from spending their money, and have the economy save? You can either force people to do (ie taxes) or offer something in return. The current wisdom is to increase the returns of savings accounts, ie, increase interest rates. With term deposit rates now in the rage of 8-9%, there's a nice incentive to put off the holiday to the Gold Coast and save.

Government bonds can 'soak up' the cash, yes. But government bonds usually are only issued to fund government spending, so the money goes back into the economy. To 'soak up' the cash, the government has one very simple tool: taxes. By running a budget surplus, the government is removing money from the economy, therefore reducing the pressure on prices to increase. And of course, the opposite is true, the government can run surpluses to increase the amount of money in the economy.

Finally, policy can also increase the amount of goods and services available to the economy in the short term to increase supply and lower prices. Interest rates effect exchange rates, a high interest rate increases the value of the Aussie dollar, and a high Aussie dollar causes the cost of imports to drop. Before you know it, we're flooded with imports.

And yes, there's all sorts of fun second-round effects to the above.

(apologies if it doesn't make sense, had a few)

Not sure why you're spamming????

UK_Merlin wrote:Not sure why you're spamming????

He probably got the blank page bug and didn't know not to press reload or post several times.

http://www.sensational-adelaide.com/for ... f=3&t=1531

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stumpjumper wrote:Question: If to increase the supply of money, a government prints more, how does it reduce the supply of money?

No one seems to have mentioned the Pauline Hanson "just print more" falicy.

One big point to realise is that money has no intrinsic value. A $100 note is only worth $100 because we all agree that it does. If you took that $100 to the moon and tried to buy some air to breath you'd be stuffed. Further the agreed value of money is a factor of the worth of the government that is backing it. It used to be pegged to how much actual gold reserves a country's government had, or in the case of the Aussie at different times, pegged to the British Pound, the US dollar, and the Trade Weighted Index. But since 1983 the Aussie is floated on the Global market and its international worth is related to our balance of payments. Very influenced by mining and farming exports, and other economies' worth causing overseas investors sheltering in the Aussie. But locally it's still pretty much a faith thing, affected by perceptions and realities in the cost of providing goods and services.

So back to my original point about Pauline Hanson's famous gaff in the House; if the Government just prints more money the worth of that money is reduced. So if all of our currency in circulation is worth X, and the government prints twice as much, it will be worth half as much.

Did that make cents? (boom boom!)

monotonehell wrote: So back to my original point about Pauline Hanson's famous gaff in the House; if the Government just prints more money the worth of that money is reduced. So if all of our currency in circulation is worth X, and the government prints twice as much, it will be worth half as much.

This is exactly what is occurring in Zimbabwe currently. They've just been printing more notes, but the value of all of their currency in circulation isn't any greater. It is also why inflation is so high over there, in excess of 1800% the last time I was aware. There are a few costs to inflation, the cost of holding wealth in money is far greater as it's value deteriorates at a greater rate, and also what is commonly known as shoe leather costs which is the opportunity cost of time spent by customers to reduce the effects of inflation on them by making more trips to the bank.

stumpjumper wrote:I'm an economic illiterate, so please help:

Assumption: Inflation is characterised by too much money chasing an amount of goods.

Actually there are three different types of inflation: cost push, demand pull, and currency slide.

Cost push inflation is caused, as the name suggests by costs going up. For example, when the cost of oil rises, the cost of fuel and petrochemicals also goes up for obvious reasons. Businesses have to pass on their costs, so they put up their prices, causing yet more inflation. Many pay deals are indexed to inflation, so the cost of labour also increases, and again many businesses have to put up their prices... so inflation causes more inflation. Some people deny this, claiming it's a circular argument. However, that objection is not valid because a circular argument can be correct in a feedback situation - indeed I'd expect a non circular argument to be wrong!

Demand pull inflation is as you describe. It is most applicable to land values (as the supply of land is fixed) but it can also apply to goods, particularly when there's not much competition.

Currency slide inflation is usually in the form of hyperinflation, and the Zimbabwean example's already been mentioned on this thread. However, it is possible to have currency slide inflation without hyperinflation - indeed the USA currently does, or at least has this year. The high value of its exports prevent hyperinflation.

Currency slide inflation is easily fixed - the government just needs to balance its budget. Demand pull inflation can be controlled by raising interest rates, although this negatively affects growth (high interest rates are almost guaranteed to cause a recession the following year) and it's quite inefficient because most businesses and many homeowners are in debt, so raising interest rates triggers some cost push inflation which partially counteracts the reduction in demand pull inflation.

Cost push inflation is much harder for governments to control, which is a great pity because controlling it is likely to be more efficient and not leave so many people worse off. It can be controlled by cutting indirect taxation, but cutting the GST (or even increasing the list of things that are zero rated) would be extremely expensive, and cutting tariffs works better as a trade deal than as a unilateral reduction. Subsidizing services also works, but again it is expensive, and governments have to be careful what they subsidize, for it will increase demand. Promoting competition has the potential to help, but in reality there's little governments can do. If the market is very inefficient, another possibility is for the public sector to get directly involved. One example it the South Australian Housing Trust, and I've just started a thread about it in the Visions and Suggestions section.

And if you understand that, you're now more economically literate than some economists!

Question: If to increase the supply of money, a government prints more, how does it reduce the supply of money? Do govts bonds soak it up (as the govt 'rents back' cahs)? Does the govt increase the liquid reserves banks have to have (seems slow method).

No. Most of the money in circulation is loaned from the Reserve Bank. So by putting up interest rates, the cost of money rises, so the amount in circulation decreases (or if it's just a small rise in interest rates, the rate of increase of the money supply decreases).

stumpjumper wrote:Whats a good basic book on economimcs for Australian society? Anyone know?

The Undercover Economist, by Tim Harford. It's British though, but the theory is the same.

Just in case you're not convinced... I highly recommend this book! It's basically an introductory economics course with the maths or jargon replaced with anecdotes. An eye-opener even for someone who's spent the last 4 years of their life devoted to the subject.