engineers, or rather engineering students are forced to cram the most mind-numbingly bizarre, useless, worthless, shittiest, senseless things ever written. in fact we spend so much time on such nonsense that we all forget to stay updated on the things that matter, such as, how to fill up govt institutions forms, how to write a withdrawal slip, how does a country make money?
i was shocked the other day when arun, wanted me to explain the concept of minting coins and printing notes. but thanks to the countless stupid things engineering students are forced to do, i could not find time for it. so here it goes.. economics 101 for arun kk.
in any economy we have something called the central bank which often operates parallel to the jurisdiction of the government. this institution is responsible for the monetary policy of the country, things like how much money to print, how to keep prices down, how to protect domestic markets from cheap foreign goods etc.
now money is an object that is universally accepted as payment for some other object. now the important point to remember here is that cash notes by themselves are worthless. (remember the Zimbabwe dollar of last year and the Deutsch mark after WW II). money has value only when it can be exchanged for something else. hence the real barometer of one s wealth is the amount of assets one has, and not the amount of money in the locker.
how does the central bank print money?
every currency has a value, that is set relative to some standard. Most countries set their currency value in relation to the amount of assets they hold. (some countries like china f*ck around with their currency value to boost their exports)
the assets could be land, government bonds, gold etc. if they have x amount of a particular asset, they can print a proportional amount of money and put it into the market. the more assets the central bank buys, the more money it can put into the market. likewise, when it sells assets, it has to take back money from circulation.
now till 1970s there was a system called the gold standard. it means that the currency of a country was directly correlated with the value of gold it held. this was a widely used system because of the following reasons :
1. it ensured that there will not be volatile changes in the value of the currency as the price of gold to a large extent is not erratic.
2. it induced deflation which generally goes down better with the public than inflation( though it can affect an economy very bad)
let us see if we can reason out why gold standard would cause deflation.
the economy is growing, more goods are being produced. but as the value of gold does not rise as steeply as the economy the amount of currency in the market is not enough for this growth. so manufacturers lower prices. this leads to deflation.
but in the 1970s this system was completely scrapped because the US felt that it made prevention of depressions and recessions difficult. you see, one way to prevent a depression is for the govt to pump in money into the economy. at such times central banks should have a longer rein to pump in money based on assets 'they hope to acquire'. while this makes depressions more difficult to occur, it literally means that the central banks today can print as much money as they want. (of course they are smart enough to do the right thing, usually) this is the reason why we see the rupee vs dollar standing at 35 two years back and 48 today. its a very volatile period for the currency market.
of course there are many many other factors which affect the monetary policy, but this is the bare sketch of it,
its been a very long blog. but i hope u learnt a thing or two. :P