Thread: Monetary Policy could never cause inflation

What Sookster said:

"If you want an idea how our banks work, I would suggest reading a document called Modern Money Mechanics that was published by The Chicago Fed. It does not talk about the inner workings of the central banks, but there are some statements as to how the central banks influence commercial banks. What I was referring to earlier was The Fractional Reserve Banking System, and it is my belief that not only does the commercial banks operate using that methodology, but the Central Banks as well. It makes logical sense. And, the document clearly states that The Fed puts a reserve requirement to the commercial banks, and that amount can change."

I completely agree with this. But we need to take this a step further. Are the reserve requirements any kind of restraint? There are two methods for banks to obtain reserves so they could lend at will: interbank lending (LIBOR), and the fed discount window.

So while the fractional reserve rate exists, it is really not an effective restraint.

Originally Posted by sookster

To make things obviously clear, inflation is when the value of the dollar goes down, whereby prices go up. So, as the overall money supply increases inflation happens. This happens naturally within the system via The Fractional Reserve Banking System, because banks literally create money out of nothing. All you have to do is watch an inflation vs time graph since 1940 when The Fed was established.

Incorrect again. Inflation is the general rise in prices over a period of time. The valuation of the dollar is a separate phenomenon that isn't tied to inflation. Inflation only refers to prices in this country, whereas valuation of our currency is effected by how other countries run their currency.

You can't simply state that printing money causes inflation without showing empirical data that it has caused inflation.

Just think about it.

I have one dollar and the entire US economy for hypothetical purposes (obviously) is 100 dollars. That dollar, is one one hundredth of the entire money supply.

The Fed prints 900 more dollars, so the overall money supply is 1000 dollars. My dollar is now one one thousandth of the overall money supply.

And, as the overall supply of money increases, overall demand for goods and services increase simply because there is more available money. As demand goes up, prices goes up, while the dollar that is owned is decreased in scarcity, hereby depreciating overall value. (Inflation)

"Money, like anything else, derives its value from its scarcity in relation to its usefulness." -->MMM

If there is money all over the place from an uncontrolled money supply, the currency is not scarce so prices have to go way up in order to satisfy the profit incentive.

Originally Posted by sookster

Just think about it.

I have one dollar and the entire US economy for hypothetical purposes (obviously) is 100 dollars. That dollar, is one one hundredth of the entire money supply.

The Fed prints 900 more dollars, so the overall money supply is 1000 dollars. My dollar is now one one thousandth of the overall money supply.

And, as the overall supply of money increases, overall demand for goods and services increase simply because there is more available money. As demand goes up, prices goes up, while the dollar that is owned is decreased in scarcity, hereby depreciating overall value. (Inflation)

"Money, like anything else, derives its value from its scarcity in relation to its usefulness." -->MMM

If there is money all over the place from an uncontrolled money supply, the currency is not scarce so prices have to go way up in order to satisfy the profit incentive.

You are forgetting the supply of goods. As money is introduced into the market, the supply of goods and services also increase.
Right now we have a tremendous amount of goods and services to be produced (unemployment), so there is tremendous capacity to print money out there.

Your instance and example would be correct if the country was producing at max capacity.

Originally Posted by JP Hochbaum

What Sookster said:

"If you want an idea how our banks work, I would suggest reading a document called Modern Money Mechanics that was published by The Chicago Fed. It does not talk about the inner workings of the central banks, but there are some statements as to how the central banks influence commercial banks. What I was referring to earlier was The Fractional Reserve Banking System, and it is my belief that not only does the commercial banks operate using that methodology, but the Central Banks as well. It makes logical sense. And, the document clearly states that The Fed puts a reserve requirement to the commercial banks, and that amount can change."

I completely agree with this. But we need to take this a step further. Are the reserve requirements any kind of restraint? There are two methods for banks to obtain reserves so they could lend at will: interbank lending (LIBOR), and the fed discount window.

So while the fractional reserve rate exists, it is really not an effective restraint.

I keep hearing this, yet I keep hearing of banks folding. So if banks have an unlimited supply of money, then how is it that they could ever go below their reserve requirments?

Originally Posted by sookster

Just think about it.

I have one dollar and the entire US economy for hypothetical purposes (obviously) is 100 dollars. That dollar, is one one hundredth of the entire money supply.

The Fed prints 900 more dollars, so the overall money supply is 1000 dollars. My dollar is now one one thousandth of the overall money supply.

And, as the overall supply of money increases, overall demand for goods and services increase simply because there is more available money. As demand goes up, prices goes up, while the dollar that is owned is decreased in scarcity, hereby depreciating overall value. (Inflation)

"Money, like anything else, derives its value from its scarcity in relation to its usefulness." -->MMM

If there is money all over the place from an uncontrolled money supply, the currency is not scarce so prices have to go way up in order to satisfy the profit incentive.

Inflation isn't the increase of our money supply, it is the increase of the portion of our money supply which is chasing goods, relative to the amount of goods being produced. Unless excess demand exists, and unless there is some reason that we can't increase our production (generally we can do that almost instantly), then there will not be inflation.

Originally Posted by imagep

I keep hearing this, yet I keep hearing of banks folding. So if banks have an unlimited supply of money, then how is it that they could ever go below their reserve requirments?

I don't follow....

Banks fail and are taken over and reorganized through FDIC because their balance sheets have deteriorated. Their assets no longer provide the means by which to meet their liabilities. It has nothing to do with reserves. All banks always have adequate reserves.

Originally Posted by imagep

Inflation isn't the increase of our money supply...

Right. Inflation is an increase in overall price levels. The supply of money is a different thing altogether. Increases in the money supply CAN cause price levels to rise, but only if nothing esle (such as the velocity of money or an increased production of goods and services) sops them up first.

Originally Posted by Cardinal Fang

Banks fail and are taken over and reorganized through FDIC because their balance sheets have deteriorated. Their assets no longer provide the means by which to meet their liabilities. It has nothing to do with reserves. All banks always have adequate reserves.

Not sure you are serious. If you are I will just mention something, but not debate. When a bank's balance sheet deteriorates it lessens the amount of equity, this is what is calculated to see what reserves a bank has. The FDIC jumps in when the bank has insufficient equity due to losses on it's balance sheet.