Money supply and banking

November 10, 2005 3:25 PM

Greenspanfilter. I've been trying hard to understand the basics of macroeconomics, and now I think I need serious help.

I really want to know how money supply, inflation, and markets are all related. I bought a few textbooks on the subject, but they typically launch off into lengthy chapters about stocks and bonds, how to run a corporation, etc, and skimp on the large-scale mechanics.

I want to know things like how inflation and deflation starts. What the purpose is of lowering or increasing the "prime" lending rate. Who is financing all our national debt, and how. I find Wikipedia is one of the better resources for detailed pieces of the puzzle (especially for providing definitions and historical cases), but I don't seem to come away understanding how the pieces fit in the big picture of national economics.

Is there any resource, analogy, game, simulator, or anything that will help me get moving in the right direction, with a working understanding of a national economy: banks, money supply, and markets? I know there is no simple explanation, but there has to be a springboard. All the resources I've checked out are just not cutting it.

posted by shannymara to law & government (10 comments total)

I don't know about games or simulators, but check out the various federal reserve websites under "education" or something similar. For instance, here all the "Ask Dr. Econ" from the San Fransisco Fed about inflation. Also, here is a pretty comprehensive primer from the NY Fed on monetary policy in general.
posted by diftb at 3:39 PM on November 10, 2005

On textbooks, if they're talking about corporation-running, they're probably not precisely macroeconomics ones. This one is lively and makes frequent reference to history in terms of government policy and effects of the same.
posted by Firas at 3:42 PM on November 10, 2005

This is an excellent site (albiet somewhat dated) that answers a few of your questions.
posted by Sagres at 4:09 PM on November 10, 2005

This is the textbook used in a Money & Banking class I took while getting my ECON BS. The text was very good (IMHO) and covers the exact topics you listed.

Disclaimer: I am not selling the book on half, just couldn't remember the name so thats where I searched.
posted by toomuch at 4:23 PM on November 10, 2005

There's a highly interesting series, Wizards of Money, that criticises the creation of money and parts of the economy as undemocratic.

I bring this up because insodoing, the woman makes many connections between the different facets of the economy--that is to say, in order to understand her criticisms, you have to understand how it fundmantally functions, first.
posted by Lockeownzj00 at 4:42 PM on November 10, 2005

I puzzled over this for a while too. It's not adequately explained by most textbooks, perhaps because if you look at the system closely, it seems quite screwed up. Basically the Federal Reserve has the power to print money, but it only does so in exchange for assets, so as to have a net zero balance sheet. There is always a supply curve and a demand curve in the economy for credit. If interest is higher, more people will loan money and less will borrow, and the reverse. Thus, the market for credit should be able to naturally clear. When Greenspan and the FOMC get together to decide what the interest rate should be, what they are essentially deciding is that the fed will either buy or sell bonds, manipulating the market, until the prevailing interest rate is what they want it to be. To make interest rates go up, the buy bonds from the open market, increasing the demand for credit, thus effectively granting credit, forcing interest rates down. To make interest rates go up, they sell bonds, effectively borrowing money from the market.

Now, the Fed mostly buys bonds, so they would need a never ending supply of cash to buy these bonds with. Luckily, they have such a supply in the form of a printing press. So when they buy bonds, they print money to buy them with. This, however, is the cause of inflation, because by printing more money, the money supply expands, making each existing dollar worth less. Thus, if the Fed tries to push interest rates too far down to stimuate economic growth, they end up creating a lot of inflation. If they try to keep inflation down, interest rates can rise. This is what happened in the eighties, when Paul Volker tried to bring inflation down from very high levels, and interest rates were very high for a long time.

Where this starts to look like a scam is the fact that the government can run large deficits, sell the bonds on the open market, have the fed buy bonds on the open market, and the fed prints money to pay for them, thus effectively having the government print money to pay for its expenses. This is one reason why periods of high deficits, such as the vietnam war, can put such a strain on the economy, because bonds that truly hit the open market displace investment in economic growth, and inflation sucks money out of the economy, making people poorer and less able to invest.

It's less of a problem in periods of technological innovation, because the increasing productivity of the workforce means goods cost less to produce, thus creating a deflationary effect, reversing some of the inflation from government spending.
posted by cameldrv at 4:54 PM on November 10, 2005 [1 favorite]

Thurow and Heilbroner's Economics Explained explains this in chapters 10 & 11. The whole book is very readable, and much smaller and lighter than most textbooks.
posted by MonkeyMeat at 5:11 PM on November 10, 2005

You can get an interesting, less-mainstream view of economics at the The Mises Institute. In my own exploration of these issues, I found these explanations to make more sense than most.

Mises is quite at odds with modern economic thinkers, so be sure to expose yourself to them too.
posted by Malor at 8:32 PM on November 10, 2005

Depending on how much reading you've been doing, this may be a bit basic, but have you read Naked Economics? It has a couple good chapters on what you're looking for, and is very good at giving a high level picture about how many of the macroeconomic factors work together.
posted by gregchttm at 8:05 AM on November 11, 2005

Although a bit expensive, Baumol & Blinder's Macroeconomics: Principles and Policy is a great textbook. It starts you from the very beginning and builds up on everything you've listed. It's written very clearly and concisely, and was used in my intro to macroeconomics class.
posted by spiderskull at 4:43 PM on November 12, 2005