Last week, Federal Reserve, the central bank of the United States of America, announced that it’s planning to increase the interest rates which marks it as the “largest interest rate increase since 1994”; Shortly after, Bitcoin experienced an increase in price.
But why FED is changing the interest rate? and what does it have to do with the crypto market?
In this episode of the “Do You Speak Crypto?” series, we’re going to talk about some of the most important terms you may often come across in the news these days as the world economy is truly faced with the aftermath of a pandemic and war!
A period of low economic activity or negative growth that may last months to years. The Great Recession is a good example that started in 2007 and lead to the creation of Bitcoin in 2008.
Bitcoin was proposed as an alternative to the traditional financial system and therefore, any negative news or failure relative to the current financial system can have a positive effect on the Bitcoin and cryptocurrency market.
In short, Monetary Policy is how a national financial institution, like central banks, controls the overall economic health of the country. They mostly do this by changing the money supply that commercial banks can offer to people and businesses.
The fancy term for “Money Printing”.
It refers to the process of increasing the money supply. In today’s financial system, this process has moved from actually printing paper money and is done through different methods.
An increase in the money supply essentially means that you have more money to spend which will stimulate the overall economy. You, the customer, buy more, leading to more demand, which translates into higher prices.
The 3 rounds of Stimulus Checks send out by the US government during the Coronavirus pandemic are good examples to consider.
The excessive expansion of the money supply can cause the prices to increase sharply, leading to inflation. With inflation, the purchasing power of the nation’s currency decreases, meaning you have to pay more to buy the same items.
Inflation can turn out quite dangerous, bringing the Hyperinflation if not controlled properly. With hyperinflation, the prices are rising more than 50% per month but it never stops there. Hungary, for instance, experienced the worst inflation in history in which the prices were increasing 15,000% per day!
Hyperinflation can completely destroy the national currency.
Central banks use Interest Rates to control our borrowing and spending. For example, by raising the interest rate, the bank makes borrowing more expensive to slow economic activities down which is a way to fight inflation.
Remember those Stimulus Checks? A new study from the Federal Reserve Bank of San Fransisco shows that those checks contributed to the US inflation rate by 3%.
At the moment, the Federal Reserve is trying to fight inflation by raising the interest rate as we mentioned above.
It’s the opposite policy of Quantitative Easing in which the central bank reduces the money supply. Simply put, they do this by leaving the bonds and securities to reach maturity and removing them from their balance sheet.
As we mentioned before, inflation is one of the negative side effects of QE, and Quantitative Tightening is another way to battle that.
Unlike inflation, deflation makes the price of goods and services drop. It seems like a good thing to pay less, but deflation is actually considered a concern by economists. It can specifically hurt borrowers as their debts are worth more than the amount they’ve borrowed.
Tightening monetary policies, like raising the interest rate, is one of the causes of deflation. Higher interest rates encourage customers to save more and spend less which can lead to lower demand and a fall in prices
With the fractional reserve banking system, banks can keep only a part of your money available for withdrawal and lend out the rest to help with the economic growth.
In severe economic conditions, people may lose their trust in banks and attempt to withdraw their money all at once. This may cause the bank to go bankrupt as they are just keeping a portion of customers’ money at hand.
Gross Domestic Product (GDP)
GDP refers to the total amount of value produced in a country during a specific period of time and is always used as a measure of economic health.
Check out your country’s GDP throughout the years, Now!
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