 |
So how does money get supplied, anyway -- doesn't the government just print it up? Well, not exactly. If the government could solve problems by printing money, there would be no problem of scarcity, after all! But, if the newly-printed money does not buy as much wealth as it used to, then it has less value. One of the most important functions of money is to provide society with a measure of value.
You might be surprised to know that most of the money in existence is not in the form of coins and paper notes. The vast majority of money exists in the form of checking deposits in banks. And it is there that money actually gets created. When a bank loans someone money, and that money is deposited in the borrower's checking account, it has, actually, been created out of thin air! The bank now has an asset (a valuable thing) on its books in the form of the borrower's promise to pay the loan back with interest. The borrower now has that money to spend. And -- as if by magic -- the overall money supply has increased by that amount!
So, now, let's return to the scene of our booming economic times. People are working; they're demanding lots of goods; factories are working overtime. The factories want to borrow money to add new production lines; consumers want to borrow money to buy new houses and cars. The demand for loans is high and banks find they can charge higher interest and still find willing borrowers. More money gets loaned (and thereby comes into existence) to pay higher prices for goods, which get costlier to produce as factories work ever-closer to their full capacity, paying higher wages to attract more workers. It's a self-reinforcing cycle -- what will slow it down?
Something will eventually come along to reverse the inflationary trend. In the old days it was called a depression: demand suddenly fell, producers cut back, workers were paid off, and times got hard. These depressions just seemed to happen -- wham! -- of their own accord, as if a speeding car had just driven off a cliff. In the modern era the more likely result is a recession: less severe than a big depression, but still an increase in unemployment, a general slowdown of production. Today, recessions are frequently ushered in when the Federal Reserve raises interest rates, in an attempt to ward off high inflation.
Indeed, capitalism has always been on a roller-coaster ride between booms and busts. Since the Great Depression of the 1930s, governments and central banks have used the tools of bank- and interest rate regulation, tax and federal-spending policy to smooth out the sudden changes -- and a vast pool of ink is spilled by learned interpreters of the boom/bust trends -- but the business cycle, and a certain level of permanent unemployment, seem to be permanent fixtures of modern "market" economies.
Background Questions
- How would things be different, if the government could simply print up as much money as it wanted, with impunity?
- Describe how banks create money by loaning it.
- Why does more money get created during a period of low unemployment?
- What is the difference between a recession and a depression?
- Why does it seem impossible to avoid a certain level of unemployment?
| Activities for this lesson | Back to Economics lessons | Discussions | Home |