Hi Wayne, thanks a lot for your videos, they are very instructive! Besides your obvious knowledge you also have great and clear didatics, congratulations! I am from Brazil, and I always try to make analogies during your videos, from the american case to our case here. One thing that I can't really picture, is how in situations like the one our country is going through right now (0% growth this year) the inflation can still be wildly out of control. Government freezed fuel and electricity prices last year as an attempt to keep inflation within the target range (we had elections for president and governors last year), increased interest rate to 12,65% (highest in the world discounted inflation) and still inflation ended up a lot above the target (6,41%). Since the country is experience a recession period, plus high interest rates, we should have deflationary pressure, correct? Any ideia of why that is not the case in Brazil?
Hey RGV, thanks for the comment! =) Sadly, I am not as familiar with Brazilian markets, but I can walk you through the questions I would ask. =) Inflation Trend (CPI) = Rising, currently at 7.70%, +0.56% year-over-year. www.tradingeconomics.com/brazil/inflation-cpi Unemployment Trend = Rising, but after a long-run trend of declining. Currently at 5.90, +0.6% year-over-year. www.tradingeconomics.com/brazil/unemployment-rate Government Deficit Trend = Declining Surplus, currently at 1.6%, -0.4 year-over-year. www.tradingeconomics.com/brazil/government-budget Interbank Lending Rate = Climbing to 12.75%, +0.5% last 90 days. Private Sector Debt Trend? Expanding at 1.4% per year www.tradingeconomics.com/brazil/loans-to-private-sector Private Sector Wage Trend? Wow, this ten year long-run trend is strange, wages have been increasing, but in a pattern that suggests heavy wage regulation. Are wages indexed in Brazil??? :O www.tradingeconomics.com/brazil/wages Summary: Brasil is on the cusp of a stagflation scenario, prices and unemployment are rising, although neither are in a danger zone...yet. So first, what is causing prices to rise? Prices rise when the amount of household spending power is expanding faster than the output of goods and services. So where is the money coming from? Not government, because they are running a current account surplus, they are taxing more than they are spending, or net savings. There has been a steady expansion of private sector loan generation and consumer credit, which is where the extra money is coming from. Hence, why your central bank has raised interest rates to 12.75%, to try to discourage household borrowing. So why are consumers still borrowing, even though interest rates have been pushed so high? It could be because of an asset bubble. Real estate prices in Brazil have been rising very fast, which would cause people to continue to borrow, as well as increase rents. As soon the Central Bank pushes interest rates above the growth in home prices, the bubble will pop. There is no obvious nominal problem with aggregate demand, since prices are rising (too fast). Inflation and rising unemployment can be caused by external price shocks, such as OPEC in the 1970s. In any case, it is typically a problem with the supply-side (output-side) of the economy. Why aren't companies creating jobs and expanding output to meet the increase in nominal aggregate demand? Why is their downward pressure on Brazilian equities markets, and a declining growth outlook? There are many things that could prevent output from expanding, but it is usually related to regulation and/or corruption. Wage and price controls are typically a bad idea and cause all sorts of market distortions. Corruption in government can also cause distortions and reduce investor confidence (this may explain downward pressure in equities markets). Inequality can also contribute to output problems. In general, bad government policy can prevent a thriving market system, and every country struggles with this issue. =/ In whole, Brazil is an amazing country who has had amazing growth and success in the very recent past. You may be going through some tough years ahead, if housing prices collapse, and/or poor government policy restricts output growth. =/ Please remember, my opinion is only a best guess - I do not closely study Brazilian politics or economy. =P
RGV I made an error in my first analysis of inflation in Brazil. I misread the government budget metric as a surplus, when indeed it is a deficit (6%+/GDP). A government budget deficit can be another source of inflation, especially if it is financed by your central bank. Another reason food prices may be increasing is drought - an exogenous shock to prices. In any case, Brazilian inflation seems to be running on all cylinders - government deficits, private sector deficits, foreign trade surplus, and environmental shock. The problem with a stagflation scenario is that it is tough to reduce inflation without hurting the economy. =/ Sorry, for the incorrect analysis...i hate making errors! =P
Wayne Vernon thanks a lot. I have been discussing your analisys here with some friends who are also interested in economy. But yes, besides everything the government debt is increasing every year, and it is already over 60% of GDP, with a big part of that having to be paid in less than 12 months, and paying around 12% of interest. On top of that the target government surplus for 2015 is $60bi, when interest itself is around $360bi, which means next year the debt will be even bigger than 60% considering GDP will not grow. Besides all that, and that Brazil has default the debt in the past. The result is that dollars vanish from economy, pushing the inflation even further, am I right? Dollar value has incresed in Brazil more than anywhere else this year. On top of that before elections government frose gas and electricity prices, and a few months after election electricity price more than doubled. Brazil is screwed... Unfortunately the populist government is dragging us down. Last week I worked in Ecuador. I remembered you. There they use american dollar as their official money. How does it work in this case? Everything works the same way as in a full reserve system?
RGV _"government debt is increasing every year, and it is already over 60% of GDP"_ Brasil has a free-floating currency, so the _"size"_ of the government debt isn't really a solvency issue. Government deficit spending becomes a problem when it causes inflation, in which case taxes would need to be raised, or spending cut. Since Brazil is facing accelerating inflation, this is an indicator that government deficits are too big. _"Brazil has default the debt in the past"_ Brasil uses a floating exchange rate fiat currency, which means there is nothing stopping government from creating enough currency to always service its debt. Basically, countries that control their own sovereign currency can never technically default. This is why i say the size of government debt doesn't matter - they can always pay their debt no matter how big it gets. Governments operating on a floating currency do not have to tax or borrow to spend. However, if they simply printed a bunch of money to spend it would create a lot of inflation, so they tax and borrow to be able to spend without causing inflation. On a macro scale, Government spending adds money to circulation, and taxation and borrowing remove it. The situation is obviously different for countries with _fixed_ exchange rates like Ecuador. When you promise a fixed exchange rate, you are no longer operating under a sovereign currency. This can be good or bad, depending on the situation. For advanced economies like Brasil or the US, fixed-exchange rates are typically a very bad idea. One reason why Europe (especially Greece) has struggled so much with recovery is they operate under the Euro, so they have all given up sovereign floating currency. In the US we have one Treasury and one central bank. In Europe, they have One central bank, and 19 Treasuries, which makes monetary & fiscal policy very hard to coordinate. The countries in the Eurozone are better understand as provinces, rather than countries. Countires adopt fixed-exchange rates for a number of reasons. In Europe, they wanted to facilitate easier trade and travel between nations, but in most cases countries promise a fixed-exchange rate because their own local currency is not trusted by investors. Lets assume you were going to create your own currency (which anyone can do) - we'll call it _RGVBucks_. Nobody will accept your currency because it is just a piece of paper with your face on it. But, what if you promised a 1:1 exchange rate with the US Dollar; 1 RGVBuck = 1 US Dollar, and on top of that, you promise a little bit of interest for those who hold RGVBucks. Now your currency has some value and people would be more willing to use it. If you think about it, this is what private banks do. They create their own currency (bank deposits), and promise a 1:1 fixed exchange rate with the national currency (reserves/cash). A _run_ on a bank occurs when everyone demands that their deposits be converted into dollars at the same time. Ecuador, or others with fixed exchange rates are no different than a private bank. Both fix their exchange rate so that people will use their currency. For private banks, a 1:1 exchange rate is the law, and for developing economies who have had recent currency problems, a fixed-exchange rate can be a good policy to attract investors. If you ever hear of a country defaulting, (Greece, Argentina, Venezuela, etc) I'm willing to bet that they have a fixed exchange rate. =P _"Everything works the same way as in a full reserve system?"_ Not really, in a Full Reserve system all demand-deposits are backed by National currency (rather than loans). Whereas, banking systems in countries with fixed exchange rates still operate like a _typical_ modern banking system. The Gold Standard is an example of a fixed-exchange rate system, except in the case of Ecuador, the US Dollar is the gold standard. Sorry for the late reply, i've been super-busy as work lately. =P
Great, thanks a lot! May I ask where do you teach Economics? Read that in another post of yours. "Are wages indexed in Brazil???" They are not, at least since 1994 (when "Plano Real" was implemented to stop the hyperinflation). But every year in January (usually) government increases the minimum wage, as one of their political moves to maintain the lower class votes. Besides that some unions are very strong in the country, and they also negociate anual wage adjustments to the entire classes. Would those 2 reasons be enough to explain the strange patern you have detacted? "Real estate prices in Brazil have been rising very fast" Did you read about that right now or just assumed? (just curious hehe). But yeah, many people argue about the real estate buble in Brazil. Prices have really ramped insanely in the last decade, but many specialists defend that it is because they were way too cheap before credit was offered to people by the current government. I am for the bubble, can't believe in what is happening with real estate prices here is real. Real estate prices have deacelerated since last year, and I think it is already lower than 12.5% interest rate, so I am not sure if there is no bubble or if that was still not enough to make it pop. What do you think? About credit you are absolutely right. Since the left party (Lula`s party) got in power, they have mainly worked in expanding credit to the lower class, even though the default rate is very big. Credit and tranfers to the lower class has been their move to try to stay forever in power, and implement their so dreamed "bolivarian revolution". But right now with recession and lots of corruption scandles right after big campain promisses, even the poor have stopped supporting them, so I guess their plans are more to the dream side now. "There are many things that could prevent output from expanding, but it is usually related to regulation and/or corruption." That is probably why. Besides regulation, and corruption, the government doesn't make enough investments in infrastructure. There are no railroads to transport crop production to the ports. Trucks stay in port line for several days, ships also have to wait sometimes weeks to load or unload. The country also ran out of electricity and water. Roads are bad, taxes are super high, and employers duties just increase with the increasing labor rights, etc. So yes, makes sense what you said, there is demand but supply doesn't grow in the same pace, thus inflation... But help me here, I asked you in the other comment too (on Money as debt movie). When you say inflation you mean the inflation caused by both money expansion and ADxAS effect? I ask that because I got confused when you said in a Full Reserve Banking System a exactly 2% inflation would be reached with 2% increase in the money supply. What about ADxAS in this math? Thanks a lot again, really apreciate it.
RGV _"May I ask where do you teach Economics?"_ Its been over a decade since I've taught economics. Today, I'm a partner in a consulting firm that provides research and data services to small business. Wage and inflation tracking is a part of my job. Although i no longer teach, I remain obsessed with economics as a hobby. =P _"Would those 2 reasons be enough to explain the strange pattern you have detacted?"_ Yes, rising wages can be a major contributor to rising prices. Some economists believe that rising wages and union influence was a major contributor (among other things) to stagflation during the 1970s in the US. If your government is increasing the minimum wage by a specific set percentage annually, that would explain the long-run wage data. By doing this the government has _indexed_ wage growth. Employers will set their labor wage expense at a specific percentage of price, say 50%. So a mandatory minimum wage increase would push employers to raise prices by the same amount to maintain wage expense at 50% of price. In the real world, employers will increase prices _before_ the predicable wage increase, or they die. So indexing a minimum wage growth rate would put employers into a pattern of constant price increases. _"Did you read about that right now or just assumed?"_ I briefly researched real estate prices after seeing the expansion of household debt. Mortgage debt usually represents that vast majority of household debt, while consumer credit is usually less than 10%. To see a climb in household debt that big, would probably require property lending (or student loans, something big). =P _"the government doesn't make enough investments in infrastructure"_ I wish the US government would also focus on this more. Politicians are masters of waste.../sigh. _" employers duties just increase with the increasing labor rights"_ Yes, which may be a reason inflation is so high for you guys. It is tough balancing the interests of labor, and the interests of employers, but if companies are struggling to expand output, increasing the marginal costs of production isn't going to help anything. Very well-intended government policies, like wage indexing, or price setting, have all sorts of consequences that are difficult to predict. =/ _"When you say inflation you mean the inflation caused by both money expansion and ADxAS effect?"_ My definition of inflation is an increase in the price of _real_ goods and services. Basically, when aggregate demand outpaces production growth. I don't use ADAS modeling unless I'm examining a specific product or service in a relatively small geographic area. ADAS is hardly ever in equilibrium on a macro scale. Instead of focusing on nominal input/output, i focus on changes in Government Deficits, and changes in Private Deficits, because this is where nominal output grows or shrinks, with or without a change in production. Governments and Banks are _leakages_ between nominal output, and aggregate demand (nominal input). To me it looks like this: (Private Net Income - Savings + Borrowing) + (Govt Taxation - Savings + Borrowing) + (Foreign Imports - Exports) = Domestic Aggregate Demand or, if solving for zero: (I - S) + (G - T) + (X - M) = 0 (I - S) = private sector balance (Investment - Savings) (G - T) = public sector balance (Spending - Taxation) (X - M) = foreign sector balance (Exports - Imports) Does that make sense? =/ _"you said in a Full Reserve Banking System a exactly 2% inflation would be reached with 2% increase in the money supply"_ This was meant only in illustrate a point, i think. It assumes no expansion of output, and assumes no savings or debt, if i remember the context. I could be wrong! Is it the old _rules-based_ monetary policy prescription from Milton Friedman?! I can't remember. =P
Very clarifying, thanks a lot! I was watching this zeitgeist movie this weekend, and I was gonna ask what you think.But I read you saying somewhere else that you don`t believe in any conspiration theories, so I think I already know your opinion :) However, I also read you saying in a comment on Money as Debt movie that intriged me a bit. At a certain point the movie affirms that if all debts were paid there would be no money. You defended in your comment that that statement is not true, because if all debts were paid we would still be left with the central bank money. However central bank money is also created by debt, government debt (bonds) in this case, am I wrong? So if all government debt was also paid there would really be no money. Or there is a flaw in the reasoning here? Another point I didn[t get is when the movie said there is no money available in a certain static point in time, for all debts to be paid, because the "interest money" is not created when someone takes a loan (including govenment). You said that is false, so could you please help me to understand that too? Thanks a lot again, and if I become to annoying feel free to kick me out :P
RGV _"central bank money is also created by debt, government debt (bonds) in this case, am I wrong?"_ The word _debt_ confuses people. Government debt held by The Fed is for accounting purposes only, it is not debt in any meaningful way. When The Fed purchases a Treasury, it erases the debt from existence, and is the exact same thing as Treasury printing debt free money and spending it into existence. It takes two transactions to get debt-free money to Treasury: *TRANSACTION ONE: The Fed purchases a bond from a bank - an asset swap* *_Balance Sheets Before Bond Purchase:_* Wells Fargo: _____________________ Reserves 50 | 130 Deposits Loans 50 | 10 Capital T-bonds 40 | Central Bank: _____________________ T-bills 50 | 50 Reserves T-bonds 20 | 20 Cash Treasury: _____________________ Reserves 0 | 110 Securities Assets 110 | *_Balance Sheets After Bond Purchase:_* Wells Fargo: _____________________ Reserves 90 | 130 Deposits Loans 50 | 10 Capital T-Bond 0 | Central Bank: _____________________ T-bills 50 | 90 Reserves T-bonds 60 | 20 Cash Treasury: _____________________ Reserves 0 | 110 Securities Assets 110 | *TRANSACTION TWO: Treasury Issues a New Bond to drain the new reserves just issued to the bank by The Fed:* Wells Fargo: _____________________ Reserves 50 | 130 Deposits Loans 50 | 10 Capital T-Bond 40 | Central Bank: _____________________ T-bills 50 | 90 Reserves T-bonds 60 | 20 Cash Treasury: _____________________ Reserves 40 | 150 Securities Assets 110 | So, when both transactions are completed, you can see that the Bank balance sheet is in its original position - nothing changed, The Fed increased it liabilities by 40, and Treasury increased its assets by 40. The Treasury is now ready to spend the new debt-free money into circulation. They do this by returning the new reserves to banks, while simultaneously crediting a deposit liability of banks. *TRANSACTION THREE: Treasury spends debt-free money by crediting a deposit account inside of a bank:* Wells Fargo: _____________________ Reserves 80 | 170 Deposits Loans 50 | 10 Capital T-Bond 40 | Central Bank: _____________________ T-bills 50 | 90 Reserves T-bonds 60 | 20 Cash Treasury: _____________________ Reserves 0 | 150 Securities Assets 150 | Notice that Deposit liabilities of Banks don't change until the third transaction, when Treasury spends. Deposit liabilities of Banks represent the purchasing power of households and companies - they are our assets. =) Taken to an extreme degree, assuming all private-debt is paid off, All deposits at banks would be backed by Reserves, and The Fed would hold an equal amount in Treasury securities - every penny would have been slowly spent into circulation by Treasury...debt-free. =) _" "interest money" is not created when someone takes a loan"_ Interest is a fee for a service...it is part of aggregate demand. It does not create or destroy money. It does not affect the monetary system. Interest is part of aggregate demand, it is someone elses income, never removed from circulation. It is literally no different than a fee for Netflix, or a dollar used to purchase a hamburger. Interest confuses people because the fee is generated at the same time as a loan, but it is nothing special. Lets say you're going to buy a house...there are lots of people involved...the Realtor, the broker, the Title Officer, the Insurance Underwriter, and finally The Bank. When the loan is generated, every person involved receives a fee. How is the fee paid to your Realtor any different than the fee paid to the bank? =P If interest payments to GDP equals 5%...Then that means 5% of peoples incomes is being used on financial services. Prof Steve Keen has done some great modeling of interest in nominal exchange..i think this is the link where he discusses interest: ua-cam.com/video/7ZK7aTBD97U/v-deo.html _"if I become to annoying feel free to kick me out :P"_ No worries, most people are not open-minded or interested enough to learn...conspiracy theories are much easier to understand! =P If you're looking for a comprehensive reading list on endogenous money systems, I highly recommend Modern Monetary Theory...here is their primer: neweconomicperspectives.org/modern-monetary-theory-primer.html
Hi Wayne, thanks a lot for your videos, they are very instructive! Besides your obvious knowledge you also have great and clear didatics, congratulations! I am from Brazil, and I always try to make analogies during your videos, from the american case to our case here. One thing that I can't really picture, is how in situations like the one our country is going through right now (0% growth this year) the inflation can still be wildly out of control. Government freezed fuel and electricity prices last year as an attempt to keep inflation within the target range (we had elections for president and governors last year), increased interest rate to 12,65% (highest in the world discounted inflation) and still inflation ended up a lot above the target (6,41%). Since the country is experience a recession period, plus high interest rates, we should have deflationary pressure, correct? Any ideia of why that is not the case in Brazil?
Hey RGV, thanks for the comment! =)
Sadly, I am not as familiar with Brazilian markets, but I can walk you through the questions I would ask. =)
Inflation Trend (CPI) = Rising, currently at 7.70%, +0.56% year-over-year.
www.tradingeconomics.com/brazil/inflation-cpi
Unemployment Trend = Rising, but after a long-run trend of declining. Currently at 5.90, +0.6% year-over-year.
www.tradingeconomics.com/brazil/unemployment-rate
Government Deficit Trend = Declining Surplus, currently at 1.6%, -0.4 year-over-year. www.tradingeconomics.com/brazil/government-budget
Interbank Lending Rate = Climbing to 12.75%, +0.5% last 90 days.
Private Sector Debt Trend? Expanding at 1.4% per year
www.tradingeconomics.com/brazil/loans-to-private-sector
Private Sector Wage Trend? Wow, this ten year long-run trend is strange, wages have been increasing, but in a pattern that suggests heavy wage regulation. Are wages indexed in Brazil??? :O
www.tradingeconomics.com/brazil/wages
Summary: Brasil is on the cusp of a stagflation scenario, prices and unemployment are rising, although neither are in a danger zone...yet. So first, what is causing prices to rise? Prices rise when the amount of household spending power is expanding faster than the output of goods and services. So where is the money coming from? Not government, because they are running a current account surplus, they are taxing more than they are spending, or net savings.
There has been a steady expansion of private sector loan generation and consumer credit, which is where the extra money is coming from. Hence, why your central bank has raised interest rates to 12.75%, to try to discourage household borrowing.
So why are consumers still borrowing, even though interest rates have been pushed so high? It could be because of an asset bubble. Real estate prices in Brazil have been rising very fast, which would cause people to continue to borrow, as well as increase rents. As soon the Central Bank pushes interest rates above the growth in home prices, the bubble will pop.
There is no obvious nominal problem with aggregate demand, since prices are rising (too fast). Inflation and rising unemployment can be caused by external price shocks, such as OPEC in the 1970s. In any case, it is typically a problem with the supply-side (output-side) of the economy. Why aren't companies creating jobs and expanding output to meet the increase in nominal aggregate demand? Why is their downward pressure on Brazilian equities markets, and a declining growth outlook?
There are many things that could prevent output from expanding, but it is usually related to regulation and/or corruption. Wage and price controls are typically a bad idea and cause all sorts of market distortions. Corruption in government can also cause distortions and reduce investor confidence (this may explain downward pressure in equities markets). Inequality can also contribute to output problems. In general, bad government policy can prevent a thriving market system, and every country struggles with this issue. =/
In whole, Brazil is an amazing country who has had amazing growth and success in the very recent past. You may be going through some tough years ahead, if housing prices collapse, and/or poor government policy restricts output growth. =/
Please remember, my opinion is only a best guess - I do not closely study Brazilian politics or economy. =P
RGV I made an error in my first analysis of inflation in Brazil. I misread the government budget metric as a surplus, when indeed it is a deficit (6%+/GDP). A government budget deficit can be another source of inflation, especially if it is financed by your central bank.
Another reason food prices may be increasing is drought - an exogenous shock to prices.
In any case, Brazilian inflation seems to be running on all cylinders - government deficits, private sector deficits, foreign trade surplus, and environmental shock. The problem with a stagflation scenario is that it is tough to reduce inflation without hurting the economy. =/
Sorry, for the incorrect analysis...i hate making errors! =P
Wayne Vernon thanks a lot. I have been discussing your analisys here with some friends who are also interested in economy. But yes, besides everything the government debt is increasing every year, and it is already over 60% of GDP, with a big part of that having to be paid in less than 12 months, and paying around 12% of interest. On top of that the target government surplus for 2015 is $60bi, when interest itself is around $360bi, which means next year the debt will be even bigger than 60% considering GDP will not grow. Besides all that, and that Brazil has default the debt in the past. The result is that dollars vanish from economy, pushing the inflation even further, am I right? Dollar value has incresed in Brazil more than anywhere else this year. On top of that before elections government frose gas and electricity prices, and a few months after election electricity price more than doubled. Brazil is screwed... Unfortunately the populist government is dragging us down.
Last week I worked in Ecuador. I remembered you. There they use american dollar as their official money. How does it work in this case? Everything works the same way as in a full reserve system?
RGV
_"government debt is increasing every year, and it is already over 60% of GDP"_
Brasil has a free-floating currency, so the _"size"_ of the government debt isn't really a solvency issue. Government deficit spending becomes a problem when it causes inflation, in which case taxes would need to be raised, or spending cut. Since Brazil is facing accelerating inflation, this is an indicator that government deficits are too big.
_"Brazil has default the debt in the past"_
Brasil uses a floating exchange rate fiat currency, which means there is nothing stopping government from creating enough currency to always service its debt. Basically, countries that control their own sovereign currency can never technically default.
This is why i say the size of government debt doesn't matter - they can always pay their debt no matter how big it gets. Governments operating on a floating currency do not have to tax or borrow to spend. However, if they simply printed a bunch of money to spend it would create a lot of inflation, so they tax and borrow to be able to spend without causing inflation. On a macro scale, Government spending adds money to circulation, and taxation and borrowing remove it.
The situation is obviously different for countries with _fixed_ exchange rates like Ecuador. When you promise a fixed exchange rate, you are no longer operating under a sovereign currency. This can be good or bad, depending on the situation. For advanced economies like Brasil or the US, fixed-exchange rates are typically a very bad idea.
One reason why Europe (especially Greece) has struggled so much with recovery is they operate under the Euro, so they have all given up sovereign floating currency. In the US we have one Treasury and one central bank. In Europe, they have One central bank, and 19 Treasuries, which makes monetary & fiscal policy very hard to coordinate. The countries in the Eurozone are better understand as provinces, rather than countries.
Countires adopt fixed-exchange rates for a number of reasons. In Europe, they wanted to facilitate easier trade and travel between nations, but in most cases countries promise a fixed-exchange rate because their own local currency is not trusted by investors.
Lets assume you were going to create your own currency (which anyone can do) - we'll call it _RGVBucks_. Nobody will accept your currency because it is just a piece of paper with your face on it. But, what if you promised a 1:1 exchange rate with the US Dollar; 1 RGVBuck = 1 US Dollar, and on top of that, you promise a little bit of interest for those who hold RGVBucks. Now your currency has some value and people would be more willing to use it.
If you think about it, this is what private banks do. They create their own currency (bank deposits), and promise a 1:1 fixed exchange rate with the national currency (reserves/cash). A _run_ on a bank occurs when everyone demands that their deposits be converted into dollars at the same time.
Ecuador, or others with fixed exchange rates are no different than a private bank. Both fix their exchange rate so that people will use their currency. For private banks, a 1:1 exchange rate is the law, and for developing economies who have had recent currency problems, a fixed-exchange rate can be a good policy to attract investors.
If you ever hear of a country defaulting, (Greece, Argentina, Venezuela, etc) I'm willing to bet that they have a fixed exchange rate. =P
_"Everything works the same way as in a full reserve system?"_
Not really, in a Full Reserve system all demand-deposits are backed by National currency (rather than loans). Whereas, banking systems in countries with fixed exchange rates still operate like a _typical_ modern banking system. The Gold Standard is an example of a fixed-exchange rate system, except in the case of Ecuador, the US Dollar is the gold standard.
Sorry for the late reply, i've been super-busy as work lately. =P
Wayne Vernon One Other reason that sovereign defaults occur: borrowing in foreign currencies (which the Sovereign's Central Bank can't print)
Great, thanks a lot! May I ask where do you teach Economics? Read that in another post of yours.
"Are wages indexed in Brazil???"
They are not, at least since 1994 (when "Plano Real" was implemented to stop the hyperinflation). But every year in January (usually) government increases the minimum wage, as one of their political moves to maintain the lower class votes. Besides that some unions are very strong in the country, and they also negociate anual wage adjustments to the entire classes. Would those 2 reasons be enough to explain the strange patern you have detacted?
"Real estate prices in Brazil have been rising very fast"
Did you read about that right now or just assumed? (just curious hehe). But yeah, many people argue about the real estate buble in Brazil. Prices have really ramped insanely in the last decade, but many specialists defend that it is because they were way too cheap before credit was offered to people by the current government. I am for the bubble, can't believe in what is happening with real estate prices here is real. Real estate prices have deacelerated since last year, and I think it is already lower than 12.5% interest rate, so I am not sure if there is no bubble or if that was still not enough to make it pop. What do you think?
About credit you are absolutely right. Since the left party (Lula`s party) got in power, they have mainly worked in expanding credit to the lower class, even though the default rate is very big. Credit and tranfers to the lower class has been their move to try to stay forever in power, and implement their so dreamed "bolivarian revolution". But right now with recession and lots of corruption scandles right after big campain promisses, even the poor have stopped supporting them, so I guess their plans are more to the dream side now.
"There are many things that could prevent output from expanding, but it is usually related to regulation and/or corruption."
That is probably why. Besides regulation, and corruption, the government doesn't make enough investments in infrastructure. There are no railroads to transport crop production to the ports. Trucks stay in port line for several days, ships also have to wait sometimes weeks to load or unload. The country also ran out of electricity and water. Roads are bad, taxes are super high, and employers duties just increase with the increasing labor rights, etc. So yes, makes sense what you said, there is demand but supply doesn't grow in the same pace, thus inflation... But help me here, I asked you in the other comment too (on Money as debt movie). When you say inflation you mean the inflation caused by both money expansion and ADxAS effect? I ask that because I got confused when you said in a Full Reserve Banking System a exactly 2% inflation would be reached with 2% increase in the money supply. What about ADxAS in this math?
Thanks a lot again, really apreciate it.
RGV
_"May I ask where do you teach Economics?"_
Its been over a decade since I've taught economics. Today, I'm a partner in a consulting firm that provides research and data services to small business. Wage and inflation tracking is a part of my job. Although i no longer teach, I remain obsessed with economics as a hobby. =P
_"Would those 2 reasons be enough to explain the strange pattern you have detacted?"_
Yes, rising wages can be a major contributor to rising prices. Some economists believe that rising wages and union influence was a major contributor (among other things) to stagflation during the 1970s in the US. If your government is increasing the minimum wage by a specific set percentage annually, that would explain the long-run wage data. By doing this the government has _indexed_ wage growth.
Employers will set their labor wage expense at a specific percentage of price, say 50%. So a mandatory minimum wage increase would push employers to raise prices by the same amount to maintain wage expense at 50% of price. In the real world, employers will increase prices _before_ the predicable wage increase, or they die. So indexing a minimum wage growth rate would put employers into a pattern of constant price increases.
_"Did you read about that right now or just assumed?"_
I briefly researched real estate prices after seeing the expansion of household debt. Mortgage debt usually represents that vast majority of household debt, while consumer credit is usually less than 10%. To see a climb in household debt that big, would probably require property lending (or student loans, something big). =P
_"the government doesn't make enough investments in infrastructure"_
I wish the US government would also focus on this more. Politicians are masters of waste.../sigh.
_" employers duties just increase with the increasing labor rights"_
Yes, which may be a reason inflation is so high for you guys. It is tough balancing the interests of labor, and the interests of employers, but if companies are struggling to expand output, increasing the marginal costs of production isn't going to help anything. Very well-intended government policies, like wage indexing, or price setting, have all sorts of consequences that are difficult to predict. =/
_"When you say inflation you mean the inflation caused by both money expansion and ADxAS effect?"_
My definition of inflation is an increase in the price of _real_ goods and services. Basically, when aggregate demand outpaces production growth.
I don't use ADAS modeling unless I'm examining a specific product or service in a relatively small geographic area. ADAS is hardly ever in equilibrium on a macro scale. Instead of focusing on nominal input/output, i focus on changes in Government Deficits, and changes in Private Deficits, because this is where nominal output grows or shrinks, with or without a change in production.
Governments and Banks are _leakages_ between nominal output, and aggregate demand (nominal input). To me it looks like this:
(Private Net Income - Savings + Borrowing) + (Govt Taxation - Savings + Borrowing) + (Foreign Imports - Exports) = Domestic Aggregate Demand
or, if solving for zero:
(I - S) + (G - T) + (X - M) = 0
(I - S) = private sector balance (Investment - Savings)
(G - T) = public sector balance (Spending - Taxation)
(X - M) = foreign sector balance (Exports - Imports)
Does that make sense? =/
_"you said in a Full Reserve Banking System a exactly 2% inflation would be reached with 2% increase in the money supply"_
This was meant only in illustrate a point, i think. It assumes no expansion of output, and assumes no savings or debt, if i remember the context. I could be wrong! Is it the old _rules-based_ monetary policy prescription from Milton Friedman?! I can't remember. =P
Very clarifying, thanks a lot! I was watching this zeitgeist movie this weekend, and I was gonna ask what you think.But I read you saying somewhere else that you don`t believe in any conspiration theories, so I think I already know your opinion :) However, I also read you saying in a comment on Money as Debt movie that intriged me a bit. At a certain point the movie affirms that if all debts were paid there would be no money. You defended in your comment that that statement is not true, because if all debts were paid we would still be left with the central bank money. However central bank money is also created by debt, government debt (bonds) in this case, am I wrong? So if all government debt was also paid there would really be no money. Or there is a flaw in the reasoning here?
Another point I didn[t get is when the movie said there is no money available in a certain static point in time, for all debts to be paid, because the "interest money" is not created when someone takes a loan (including govenment). You said that is false, so could you please help me to understand that too?
Thanks a lot again, and if I become to annoying feel free to kick me out :P
RGV
_"central bank money is also created by debt, government debt (bonds) in this case, am I wrong?"_
The word _debt_ confuses people. Government debt held by The Fed is for accounting purposes only, it is not debt in any meaningful way. When The Fed purchases a Treasury, it erases the debt from existence, and is the exact same thing as Treasury printing debt free money and spending it into existence. It takes two transactions to get debt-free money to Treasury:
*TRANSACTION ONE: The Fed purchases a bond from a bank - an asset swap*
*_Balance Sheets Before Bond Purchase:_*
Wells Fargo:
_____________________
Reserves 50 | 130 Deposits
Loans 50 | 10 Capital
T-bonds 40 |
Central Bank:
_____________________
T-bills 50 | 50 Reserves
T-bonds 20 | 20 Cash
Treasury:
_____________________
Reserves 0 | 110 Securities
Assets 110 |
*_Balance Sheets After Bond Purchase:_*
Wells Fargo:
_____________________
Reserves 90 | 130 Deposits
Loans 50 | 10 Capital
T-Bond 0 |
Central Bank:
_____________________
T-bills 50 | 90 Reserves
T-bonds 60 | 20 Cash
Treasury:
_____________________
Reserves 0 | 110 Securities
Assets 110 |
*TRANSACTION TWO: Treasury Issues a New Bond to drain the new reserves just issued to the bank by The Fed:*
Wells Fargo:
_____________________
Reserves 50 | 130 Deposits
Loans 50 | 10 Capital
T-Bond 40 |
Central Bank:
_____________________
T-bills 50 | 90 Reserves
T-bonds 60 | 20 Cash
Treasury:
_____________________
Reserves 40 | 150 Securities
Assets 110 |
So, when both transactions are completed, you can see that the Bank balance sheet is in its original position - nothing changed, The Fed increased it liabilities by 40, and Treasury increased its assets by 40.
The Treasury is now ready to spend the new debt-free money into circulation. They do this by returning the new reserves to banks, while simultaneously crediting a deposit liability of banks.
*TRANSACTION THREE: Treasury spends debt-free money by crediting a deposit account inside of a bank:*
Wells Fargo:
_____________________
Reserves 80 | 170 Deposits
Loans 50 | 10 Capital
T-Bond 40 |
Central Bank:
_____________________
T-bills 50 | 90 Reserves
T-bonds 60 | 20 Cash
Treasury:
_____________________
Reserves 0 | 150 Securities
Assets 150 |
Notice that Deposit liabilities of Banks don't change until the third transaction, when Treasury spends. Deposit liabilities of Banks represent the purchasing power of households and companies - they are our assets. =)
Taken to an extreme degree, assuming all private-debt is paid off, All deposits at banks would be backed by Reserves, and The Fed would hold an equal amount in Treasury securities - every penny would have been slowly spent into circulation by Treasury...debt-free. =)
_" "interest money" is not created when someone takes a loan"_
Interest is a fee for a service...it is part of aggregate demand. It does not create or destroy money. It does not affect the monetary system. Interest is part of aggregate demand, it is someone elses income, never removed from circulation. It is literally no different than a fee for Netflix, or a dollar used to purchase a hamburger.
Interest confuses people because the fee is generated at the same time as a loan, but it is nothing special.
Lets say you're going to buy a house...there are lots of people involved...the Realtor, the broker, the Title Officer, the Insurance Underwriter, and finally The Bank. When the loan is generated, every person involved receives a fee. How is the fee paid to your Realtor any different than the fee paid to the bank? =P
If interest payments to GDP equals 5%...Then that means 5% of peoples incomes is being used on financial services.
Prof Steve Keen has done some great modeling of interest in nominal exchange..i think this is the link where he discusses interest:
ua-cam.com/video/7ZK7aTBD97U/v-deo.html
_"if I become to annoying feel free to kick me out :P"_
No worries, most people are not open-minded or interested enough to learn...conspiracy theories are much easier to understand! =P
If you're looking for a comprehensive reading list on endogenous money systems, I highly recommend Modern Monetary Theory...here is their primer:
neweconomicperspectives.org/modern-monetary-theory-primer.html