How Does Money Affect the Economy

Introduction

• Understanding the market economy
  • Familiarity vs. technical understanding
• Objective: To understand how money affects the economy

Basic Concept

• Analogy: Excess lawn mowers
  • If you have more lawn mowers than you need, you get rid of the excess.

Excess Money Balances

• Spending example: Spending $1,000 a month
• Analogy: Money like lawn mowers
  • If you have extra money (e.g. $2,000 instead of $1,000), you will spend the excess.
• Economists term: Excess money balances
  • More money supply than money demand
  • Similar to having too many lawn mowers

Rebalancing the Portfolio

• Ways to get rid of excess assets
  • Garage sale for lawn mowers
  • Spending excess money
• Balancing assets
  • Switching from money to goods like jeans, vacations, etc.
• Increased spending stimulates the economy

Monetary Theory

• Simple ideas form the basis
• Influences on the economy by the Federal Reserve
  • Increasing the money supply

Mechanism of Money Supply Changes

• Federal Reserve increases the money supply
• Banks make loans
  • Loans for big-ticket items: Cars, houses, factories
• Increased spending from loans stimulates the economy

Impact on the Economy

• Short-term effects: Increased spending
• Medium-term effects: More jobs, lowered unemployment
• Long-term effects: Inflationary pressures, increase in prices

Practical Examples of Money Supply Impact

• Increased money supply
  • Banks have incentive to loan money
  • Quick spending on inventories
  • Gradual increase in jobs and manufacturing
• Time frame of impacts
  • Jobs: Around six months
  • Inflation: Around a year to two years
• Federal Reserve's role
  • Adjusting money supply to control inflation

Deficient Money Balances

• Example: Less money than needed
  • Reduced spending
  • Unemployment increases
  • Economic contraction

Conclusion

• Importance of understanding how money supply affects the economy
  • Microeconomic vs. macroeconomic impacts