Dusting off the High School Economics Textbook.

 

With all the turmoil in the markets (both financial and grocery) I thought it would be a good idea to go back and reeducate myself on basic economics.  That way when I lose my mind over the current administrations policies I am a least a little bit familiar with the academic side of things.  That said I am fully aware of my vast knowledge void in this area.  Since I acknowledge this shortcoming of mine, it is best to start at the beginning.  So what is "Economics"?  Merriam-Webster defines economics as:

"A social science concerned chiefly with description and analysis of the production, distribution, and consumption of goods and services"

I do like Google's AI generated definition:

In simple terms, economics is the study of how societies use their limited resources to satisfy their unlimited wants and needs. (My emphasis)

I like how the AI generated definition admits that resources are limited while wants and needs are unlimited.

Many of may have heard the terms micro and macro economics.  I have been discussing some elements of microeconomics in this blog.  I have mostly discussed this topic from the periphery.  Many of my posts have been about the decisions we make and how they affect our lives. These decisions are mostly microeconomic in action.  Many of my posts have centered around behavioral economics.  Google's AI generated definition for microeconomics is:

the study of economics in terms of individual areas of activity, such as a firm, or the behavior of individual consumers.

In many of my post I have written about our decisions regarding money.  One of the shortcomings of microeconomics has been the assumption that we make purely rational decisions.  That is why I have found the field of  behavioral economics quite compelling.  We are not exclusively rational and therefore our decisions are not always rational.  Richard Thaler coined the term "Econ" to describe the mythical, purely rational entity described in traditional microeconomics.

The area of economics that I have rarely discussed is macroeconomics.  Again with the Google AI generated definition:

Macroeconomics is the branch of economics that examines the overall performance, structure, behavior, and decision-making of an economy as a whole, including regional, national, and global economies

I have avoided posting about macroeconomics since it has very little to do with our day to day decisions.  Who looks at recent GDP figures and then decides to buy a car? However given recent events it seems to me that a little understanding of macroeconomics is appropriate.  So here we go, a crash course on macroeconomics.  Any one who has watched the national news has probably heard these terms before.  What is usually missing in most national news casts is how these concepts interact and affect our lives.  In the end what should cause us concern.  Also many of these concepts are represented in different ways.

Describing macroeconomics is easy enough.  Governments and central banks want their economies to grow as measured by their Gross domestic product (GDP).  At the same time keeping inflation and unemployment low.  As I said, easily defined not so easy to achieve.  Even more simply growth (GDP goes up) and stability (low unemployment and low inflation).  Governments and central banks have a variety of tools to achieve these results.  They fall into 2 categories;  fiscal and monetary.  Fiscal policies are controlled by elected officials (in our case congress and the President) and monetary policies are managed by central banks (In our case the Federal Reserve).  Ultimately the Federal reserve is overseen by a board of governors that are appointed by the President and are approved by the senate.  You really want to torture yourself try this Wikipedia article.

The basic idea of any of these tools is to manage the money supply and either stimulate or subdue the economy.  When money is injected into the market the economy is stimulated and when money is removed the economy is subdued.  One tool is open market operations.  The fed buys and sells its securities.  From Investopedia:

Open market operation (OMO) is a term that refers to the purchase and sale of securities in the open market by the Federal Reserve (Fed). The Fed conducts open market operations to regulate the supply of money that is on reserve in U.S. banks. The Fed purchases Treasury securities to increase the money supply and sells them to reduce it.

To stimulate the economy the central bank takes money out of its pocket buys securities and that money somehow ends up in our pockets and we spend it and the economy is stimulated.  The opposite is where we take money out of our pockets and buy securities and the money leaves the market and is held by the central bank.  I believe that this mostly happens through large banks but the basic idea is there.  Money dispersed by the central bank stimulates the economy and money held subdues it.

Another tool used by central banks are reserve requirements.  Large banks are required to keep a certain amount of money in reserve.  This reserve cash protects a bank in case of a surge of withdrawals (a so called run on the bank, for an example watch the movie "Its a wonderful life").  The higher the reserve rate the less money banks have to loan out and less money in the market.  The lower the reserve requirement the more money banks can loan out and more economic activity.  Once again Investopedia explains.

These two tools used by central banks are rarely mentioned in the news.  Those of you who may watch CNBC or other financial news channels may have heard of them.  However they almost never directly affect us.  The third and final tool is much more prominent in our lives and that is the discount rate.  This is the rate that a central bank charges commercial banks when they borrow money from them.  Yes it is true large banks rely on loans from the Federal Reserve to remain solvent.  If the discount rate goes up banks then need to charge more for the loans they grant.  This means that mortgage, car and personal loans get more expensive and people are less likely to borrow.  People and business now have less money to spend and the economy slows down.  When the central bank reduces the rate interest rates on the loans banks grant goes down.  You and I then are more likely to purchase homes and cars.  As credit card interest rates fall personal spending goes up and the economy is stimulated.  May as well stay with Investopedia for this definition as well.

So there it is money into our pockets stimulates the economy money taken out stifles it.  Nest post the problems with all this.