Money and Banking: Lecture 1 - Money and the Economy

you okay let's talk just a little bit and we'll continue this next time but talk just a little bit about how does money affect the economy now as there are so many things you know we've all been working or interacting with each other out in the market economy throughout there our lives and so we feel really comfortable with this market economy is just out there where anything's being bought or sold and so if you go to a vending machine and pump a few quarters into that and get a soda you're in the market economy so everybody's familiar with this and we have this sort of familiar understanding but it's not a real technical understanding how that works and so what we want to do this is money in banking we want to talk about money what how does money affect the economy and we want to go beyond the old well you know how it happens yeah I do know how it happens I want to make sure you do okay and so we'll be a little bit more technical than just boy if I got more money I'm buying more stuff that would be true but that is not a technical analysis and it doesn't really allow us to understand things and more depth and so I always like to start off with an analogy something kind of simple and so let me let's start it off this way let's say you go home and you raise up your garage door and there are five lawnmower set in there and you go holy macro I got five lawnmowers I don't need five lawnmowers I need one maybe two you know one of them to do like close work around the shrubs or something like that one of them oh the yard I don't know one or two on Moore's is enough array but if you've got five you got too many lawn mowers right and what do you do you just say well I got five on mowers gosh I hate that no you get rid of the extras well you know what money is kind of that way too let's just say that and whatever your expenditures are maybe you're spending $1,000 a month just to pick some number you spend a thousand dollars month after month after month and this is just how much you normally spend as $1,000 a month then you probably start the month off after your payday and that sort of thing paycheck you start the month off you got a certain amount of money in your bank account and you get a certain amount of cash you got a certain amount of money and so for your $1,000 worth of spending during the month you've got some amount that you traditionally need of money money in the checking account money in your pocket cash you've got a certain amount of money that you need to carry out the business that you normally carry out during the month and it's the same thing as it is and whatever that amount is maybe you've got twelve hundred dollars two hundred dollars in cash in a thousand dollars in your checking account whatever the amount is it's kind of like those lawn mowers suppose that you'd get your bank statement and it says you have two thousand dollars in your checking account and you go huh I've got two thousand dollars in my checking account but you know what I normally I have a thousand bucks I can get through the most of the thousand bucks I've got an extra thousand dollars now we don't mean you've got an extra thousand dollars you hate that but we mean you've got an extra thousand dollars over and above the amount you normally me need to carry on the life that you normally carry on and this is sort of like having all those lawn mowers in your garage and when you got all those lawn mowers in your garage you're going to get rid of them and guess what when you got all that money more than you normally would have an extra thousand bucks you're going to get rid of that now I don't mean to say you're going to burn it up I mean you're going to do something that's going to affect your behavior and so when the amount and this is not only true for you as an individual but it's true throughout the economy as a whole if we had everybody up but when the money supply is greater than money demand and this money demand this what is normally needed for what typical needs when we had this situation of money supply is greater than money demand economists have a term for that what we say is that there are excess money balances excess money balances this a little bit like the lawnmower situation you got too many lawn mowers you get rid of them now how can you get rid of a lot more as well you can have a garage sale you could donate them to charity you could give them the neighbors how do you get rid of money well yeah you could give it away you know what most people do with it they spend it right lawn mowers are just an asset and if you've got too much of that kind of asset what you do normally you have a garage up put a sign up there says lawn mowers for sale somebody comes along and buys them and what you're saying there is hey I had this asset lawn mowers I got more of that asset than I need I want to trade that for some other asset and the asset you in the first instance you trade that for is money you sell that lawn more let's say you put a sign this is lawn mowers fifty dollars a piece you put four lawn mowers out in your front yard people come along here is 50 bucks 50 bucks 50 buy all of a sudden you got $200 so that's the asset you traded those lawn mowers for cash and now you take that cash and go out and get something else maybe what you do is buy some clothes maybe you go to dinner maybe go out to a movie maybe use that to go on spring break okay but this is just a matter we all of us have certain assets and we're trying to balance those assets what assets can I hold that serve me best and the same thing is true if you've got a thousand dollars of money assets over and above what you normally need and have to conduct your business then this is just an asset that's out of balance and so then what you say is this gosh I always wanted I don't know a new pair of jeans or I always wanted to go to Ford on spring break these are other assets that you want to have and when you've got this extra thousand bucks and your assets are out of balance you've got too much money asset and not enough these other assets that you'd like to have and so when you balance your portfolio you get this extra money asset and you get more of this other asset whatever it is new pair of jeans and this whole idea of getting rid of money assets and getting more jeans we call that spinning right you just take some money out to the mall and buy a pair of jeans and we would just we would normally say oh that person has rebalance their portfolio of assets away from money and toward jeans we don't use that terminology what we say is I will now bought a pair of jeans and so when we go back to this if we have a situation where for you personally or for the US as a whole when money supply is greater than money demand and again I mean that by the amount of money we need for our typical purposes when money supply is greater than money demand we are out of balance with our assets we've got excess money assets and when we rebalance our portfolio we get rid of some of that money in order to get these other assets and so what we say is that there's an increase in spending and this is the thing that stimulates the economy are we doing so far okay kind of simple isn't it and I think you know a lawnmower you could use anything else as you know an example to illustrate this but it's really not complicated stuff we call this monetary theory by the way and you know you can go to graduate school and study monetary theory and be the chairman of the Federal Reserve and so forth but it really kind of comes back to these fairly simple ideas now in the first instance what happens like on any given day you might start off where money supply and money demand are equal for you personally you might say oh I need about start to month off of the thousand dollars in my bank account two hundred dollars with the cash and that's what I have and then you just go about your ordinary business when the Federal Reserve does something to increase the money supply and we'll get into what it does later on but when the Federal Reserve does something to increase the money supply that's when we get these excess money balances money supply goes up you start off with the Equality here money supply goes up and all of a sudden money supply is greater than money demand for the US as a whole and that may not affect you in the first instance maybe money supply is greater than money demand not your money supply so you just go on about your business the way you've been doing but when the Federal Reserve if they put another billion dollars in the economy somebody or some many somebodies have got that billion dollars and whoever it is it's possessing that billion dollars for them there are excess money balances and they get out there and start spending more than they were before okay and so that's how the economy gets stimulated usually the way this works and I mentioned a little while ago is the Federal Reserve will do business with some bank and so the in the first instance the Federal Reserve's putting that money in the economy or those funds at some Bank some bank starts making loans if you go to the bank you get a loan you know what they do with that money if you say I want to buy for a loan I want to buy a car $20,000 you're approved for the loan you sign all the documents did what then they say we'll put that $20,000 in your checking account in that checking account that's money and so that's where your money supply would be greater than the normal amount of money you need to do your business and you say oh gosh I got an extra twenty thousand bucks so what do we do we go out and spend that we buy that car now the people who are selling cars say oh gosh look at that sales are up and then the people are selling cars they say gosh we just sold some cars off the the lot off the showroom floor let's order some more cars we need to get some more to replenish our inventories so then they call it General Motors or Ford or Toyota whoever this is and they say send us some more cars and then General Motors or Ford or Toyota says okay and then they tell the workers hey make a car for us or some cars so now there's somebody else is being affected somebody in Detroit or somebody in Kentucky or somebody in Missouri someplace like that they're making these cars and so when we see this and it's just too complicated to draw a picture there are thousands and thousands of places this money could go but this stimulus of the economy this extra spending that occurs it just goes to all sorts of places and so that's how the stimulus affects there goes into the economy usually what happens and I just mentioned a moment ago is when the money supply is going up these banks are making loans to people and you know when banks make loans to people it's usually for I don't mean to say just one or two things but a fairly narrow range of items like we don't go to the bank and say I'd like to take out a loan so I can get a newspaper in the morning I want to take out a loan so I buy breakfast I want to take out a loan so I can get a haircut that's not it we tend to take out these loans in order to buy a car in order to buy a house in order to buy a motorcycle something big-ticket item a boat companies go get loans at the bank but usually when these companies are taking out loans at the bank they're trying to buy something like oh I want to buy a warehouse or a factory or I want to buy some delivery trucks or whatever and so when this these loans are made and the money supply is growing and then we get this extra spinning the stimulus to the economy is not like more newspaper newspapers to be sold or more breakfast will be sold it's not that kind of thing it tends to be for these big-ticket items okay and so there will be something that happens like there are more jobs let's say more manufacturing jobs right and then there'll also be more demand for let's say energy what do you mean energy I mean that if there's if cars are being produced you don't just have a big factory that's producing cars without having a lot of electricity and things like that being used in that factory and there will be demand for raw materials let's say demand for steel if it's a car that's being manufactured as steel and tires and any number of other things now so here are these more manufacturing jobs now we've got more people working on the assembly line and they're putting these cars together and then guess what they get paychecks right and so then the guy or gal who's working on that assembly line they get a paycheck and then they go out and spend that paycheck Oh demand for groceries add demand for clothes now here's where this money starts getting into the general economy so the Federal Reserve did something to begin with some credit was created a loan was made whoever borrowed that money you don't go borrow money just to see if you can borrow it you bought it so you can buy something so now you go buy something let's say cars ok stimulates your car here's the cars and so that stimulates the car business but now the people who are supplying things to the car business services and commodities and so forth they get that money and now they're just buying everything you know car workers are sending junior to to grade school car workers are going on vacation car workers are eating at restaurants car workers are just whatever you can imagine they're doing us and so a few steps down the road or down the and our logical process a few steps away these dollars are entering the general economy if there's a demand for steel for example here's a demand for energy so people working at utilities are going to start getting money and the people who are supplying coal to the utility companies are going to get money and these funds are going to work their way into the economy and so it takes time but not a lot of time ok because if you come back and look at this at the Federal Reserve increases the money supply today and provides funds to banks and banks don't just sit around going ok we got a bunch of funds that's fine they don't do that what they say is hey we got these funds from the Federal Reserve you know if we get busy and make loans we'd get some interest coming in and so they've got an incentive to get this money into the economy and the incentive is the interest and so when the banker starts making loans to people people don't just take out loans for the heck of it they take out a loan for a purpose I want to buy a car and so when people go out and buy those cars that's pretty fast and then when the car seller starts in or the dealership starts selling those cars they're placing those orders and it doesn't take very long for the car manufacturer to say hey we need this or that or the other and so this money spreads through the economy fairly quickly and I don't mean to say in a matter of a couple days or anything like that we're not talking about one of these days within a few months that money is getting pretty busy in the economy and we start seeing these effects down the road here's what we're seeing here more manufacturing jobs employments up that's the numbers that we would start seeing that are released by the Bureau of Labor Statistics employment Rose unemployment's down eventually this demand for cars the demand for energy the demand for steel the demand for things these people out here buying groceries they're buying clothes this demand is eventually going to be pushing putting upward pressure on prices the people who are selling cars and clothes and whatever all raw materials those people are going to go gosh we're selling a lot more of our stuff whatever that stuff is we're selling a lot more that than we used to let's raise the price and so then we start seeing statistics and it takes months for this to happen but we start seeing statistics hay prices are going up hey we got inflation the economy is expanding jobs are being created and now we're getting inflation in the economy okay and so these things take time the very quickest things that happen is the loans are made and people go out and start buying things with those loans and I'm just using cars as our example that happens right away but with a little bit of a leg you know people go out and start buying cars the first thing that happens is we're buying inventories those cars are already in the showrooms are already out in the back lots of car dealerships and so forth so there's not a lot of jobs created that day but once those inventories get depleted that's when those manufacturers start hiring more workers and start increasing production so after a few months we start seeing more jobs and seeing unemployment go down and then several more months we start seeing the inflationary pressures the prices going on just to give you a ballpark number in terms of how long it takes we're talking around supply goes up today through this process of banks making loans and so forth we're talking of about six months until we start seeing the jobs appear okay sometimes a little left sometimes a little more but around six months could be nine months and until we start seeing the inflationary pressures the price is going up and we can see sort of the leading edge of it sooner but in terms of how long does it take for this to really kick in a year year and a half sometimes as long as two years sir right now no because what happens is you know if you have a lot of people that are looking for jobs you know and there's a lot of companies with a lot of inventories and they're trying to sell them then they're just so happy when there's more spending and willing to go to work without a pay increase like okay I'll take what you're offering and the people who have all these inventories that they haven't sold they're willing to sell that you know like without raising the price they're just happy to get rid of it and so if you have more slack in the economy you know as you do during a recessionary period more slack in the economy then that doesn't feed to the recession or to inflation nearly as quickly but I mean if this persists if you just keep on increasing the money to buy more and more rapidly then there will be a day and how long it depends on the particular situation that's why I said a year or two there will be a day when that leads to inflationary pressures the Federal Reserve and the present instance the Federal Reserve said we're going to increase the money supply but when we see the economy start to respond we're going to take some that money back and so they're not just going to keep on increasing the money supply and say hey let's see what happens they know what will happen so what they say is hey the economy start moving we're seeing more spending we're seeing some jobs now it's time to start pulling some of that money out of the economy so we don't get a lot of inflation least that's the theory of it and if they make a mistake then you know we're going to get inflation but I mean that is where the inflation comes from you know if you think about this this money thing is very important to cause an inflation because let's just say hypothetically that the money supply did not go up the Federal Reserve doesn't do anything there's no increase in the money supply and let's just say everybody it's got something for sale says let's increase the price 10% let's increase the price of bread 10% price of cars 10% price of newspapers chili just whatever it is 10% well they're all doing this where do we get the money to pay for that you know I mean I only have a certain paycheck you have a paycheck you go ahead you want to buy stuff and if everybody is increasing the price 10% I just can't buy all the stuff I've been buying and you can't buy all the stuff you've been buying and neither can anybody else and so the people who are raising the price 10% they start getting disappointed gosh I reached my price 10% now I'm not selling as much as I used to I guess I shouldn't have done that now if we had an increase in the money supply and I got 10% more money in my pocket and you got 10% more money in your pocket the next person the next door we all got more money in our pocket and then the people who sell things are raising the price 10 percent I can still afford to buy all that stuff paid the extra 10 percent for that stuff and I still buy as much as I used to so you've got to have that extra money in the economy for prices to go up and for that to stick you know for prices to go up and persistently go up for us to have inflation there's got to be more money in the economy and if we don't have the money supply a company in that where you have prices go up and then a bunch of bankrupt companies and then prices start coming down when they put everything on sale so money is an essential part of this inflation story anyway so what I'm saying to you is this is that what happens to the money supply if there was an increase in the money supply it's not like well you know everybody spins but yes they do but there is a chain of logic that you need to follow in order to sort of figure out what's going to happen and that way you don't go I don't know somehow or another the price of Chile will go up how is that at what point what would cause that you know and the answer is way on down the road with the price of Chile much more likely that if the money supply goes up there's more credit people are buying the big-ticket items and we start seeing the stimulus there first okay and then we start tracing this through and so there is this process for us to follow and then where we see all this we don't see all this in one place we're talking about the concepts here economics class we talk about the concepts what we do see though is that we see these reports coming out from let's say the Bureau of Labor Statistics employment as a unemployment is down and we see an inflation report that we don't see something demand for close up what we see is hey the price of clothing is going up the price of food is going up and so gosh well I wonder why those prices are going up because of the extra demand for those things and so we're seeing economic data that reflects this underlying process and this is basically how this money works its way into the economy and this is why it's so important for us to understand this we start off with a situation where money supply and money demand are equal and both on for the average individual for the economy as a whole and for us to understand what's going to happen in the economy we have to start paying attention to what's happening basically to the money supply part of the story this usually money demand is not very you know it doesn't fluctuate wildly and so forth if you start off saying oh gosh I spend a thousand dollars a month I need about a thousand dollars at the beginning of the month of my checking account two hundred dollars or the currency that's more or less the same month after month after month and could go on indefinitely right but what can change at a moment's notice is the Federal Reserve can get in there and do something to the money supply and it can upset this imbalance let me close by saying this it's not always the Federal Reserve increase in the money supply what if we've got an equality here and the Federal Reserve decreases the money supply then we'd have a term where we'd say not access mission money balances and if we have deficient money balances here's what that feels like you normally start the month off with two hundred dollars or the currency and a thousand dollars in your check that's normal and though the mail carrier comes you get the mail you open your bank statement and says you've got $800 in your checking account and you go oh my gosh I've got $800 in my checking account how am I going to get through this month and somebody says hey let's go out to dinner tonight you say I can't afford it hey let's go to a movie I don't think so hey let's go get a new pair of jeans no way I'll wear the old ones and so when the money supply goes down and we have deficient money balances money supply less than money demand then what we see is this whole process is reversed spending decreases people are saying gosh I got to do something about this situation I'm out of money spending decreases there aren't as many jobs there's not as much utilities sold there's not as much steel sold and you can work your way through the process the auto workers are not working overtime they're not buying new clothes and they're not going out to dinner and so forth and it works its way through the economy that way and so it's very important for economic conditions you know I know as individuals in the micro economy we know that it'd be nice to have more money we know it'd be bad to have less money but what I'm saying to you is that this same little story that we as individuals feel playing out on a day to day basis the overall economy feels that as well on a macroeconomic level that's it for today and we'll go on next time talk about this and get into the next chapter material so long

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Length: 27min 44sec (1664 seconds)

Published: Fri Feb 01 2013