There is only so much that watching and reading the news can tell you about the subject of money and banking. Much of this news is aimed at an audience that knows very little about what goes on behind the scenes of our economy, and the news on business channels such as CNBC and Bloomberg is very technical and can go over my head at times. Part of the reason I embarked on this degree program was to understand the technical side of finance and economics. It is now my job to present my knowledge to those who know very little about this subject. With that, I present the three most important things I learned.
The first important thing I learned is about inflation. Inflation is a term heard a lot in the news, and in its most basic form it represents an overall rise in prices. Inflation reduces the purchasing power of earnings in that if you make the same amount of money each year, inflation pushes the prices of what you need upward, and your money buys less of what you need each year.
A little inflation each year is not a bad thing. Hopefully—but not always—wages go up to match inflation, keeping purchasing power the same. However, there are a few things that I need to clarify about inflation. First, just because the price of oil and gas has gone up does not necessarily mean that we are experiencing inflation. There has been a perceived supply shock causing a rise in the price of oil, which has a ripple effect on the prices of products derived from oil, such as gasoline and plastics, but this does not necessarily mean that prices are going to stay higher. As we’ve seen in the past, the price of oil can be very volatile, and it is quite possible that this shock and the price increase associated with it will eventually subside.
A more permanent cause of inflation is the money supply; that is, the amount of money that is currently in the financial system. The more money we have in the system, the more things will cost because there is an imbalance in the supply and demand curves of the money supply. If there is an increase in the money supply, demand for money will increase until there is equilibrium between supply and demand.
As a teenager, I recall watching one episode of Disney’s DuckTales in which Huey, Dewey, and Louie discover a machine that helps them replicate anything they want. They soon discover that they can duplicate Uncle Scrooge’s coins and become rich. The problem they soon face is that while they seem to be rich beyond their wildest dreams, suddenly everything in town costs a lot more because suddenly, there’s more currency in circulation! Little did I know it, but I was being taught a lesson in inflation that day. This cause-and-effect relationship between the money supply and inflation can be summed up in Milton Friedman’s famous quote, “Inflation is always and everywhere a monetary phenomenon.”
The second important point I learned in this class is the actual role of the Federal Reserve System. As we know, the...