A slightly less abstract summary is “assigning scare resources”.
Imagine that you are a world dictator, and to keep things simple, you want to build an agrarian utopia. However, instead of Pol Pot, you are actually not an evil guy, and you genuinely want people to live happily and have enough food.
Okay, so you have a certain budget each year. Or, to remove the complications of using money, you have a certain amount of resources (including man-days) that you can spend during that year. How much will you (make your subjects) spend, assuming that they are 100% obedient, so no need to actually spend most money on your personal security...
literally digging in the garden (manually, or using a machine)
drilling and refining oil for the machine
mining the iron for the machine
researching a better type of machine
transporting food from place A to place B
oil / iron / research for the transporting machines
or maybe you should instead resettle people from place B to place A
building the new houses
...it gets complicated quickly. And the more you think about, the more complicated it gets. For example, you still need some form of education, even if it is “narrowly” focused on agricultural work, iron machine design, construction, etc.
One part of the “economy” is that these things often just happen, by random people finding their personal motivation (often profit) to research them, do them, and maybe suffer a personal loss if their guess was wrong.
IDK if it’s historically true, but I’ve read that the origin of coinage was to make it possible for governments to automate the provisioning of their armies. Instead of directly controlling it all, you mint coins, give them to soldiers, tell the soldiers what they’re responsible for, and make a law that every citizen has to pay a certain amount of those coins in taxes each year. Directly or indirectly, everyone has to do something to benefit the soldiers in order to get those coins.
Indeed. And this is actually another angle through which I encountered the question in the OP. Sometimes the government tries to control the economy by changing the properties of money, e.g. changing the central bank rates in order to cause inflation. But I would like to get a better mechanistic understanding of which decisions shift in response to the interest rates. I think I kind of get the dynamics within finance, but finance is very abstracted from the object level.
Ok, then if we set finance aside, we’re left with a set of resources that can be used for all sorts of purposes. Minerals, land, plants, animals, equipment, people, skills, knowledge, etc.
Then some entity creates some form of money, and we all agree to use it as the unity of account and medium of exchange and store of value. That can happen in different ways, like the one I mentioned in the previous comment. At this point, people want money because money is the tool that lets them get other things that have value to them.
People start producing things of their choice and selling them for a price of their choice. By this process they learn, individually and collectively, what prices other people are willing to pay. Scale it up and we get market prices and efficient markets for goods and services. Everything has a price relative to everything else. That price changes over time for all sorts of reasons.
The government can manipulate the overall level of prices, aka inflation and deflation, by altering the amount of money in circulation: unless we increase our productive capacity or decrease consumption, more money chasing the same goods and services means prices go up. It can also change relative prices through selective taxes and subsidies. Or by purchasing stuff, which affects prices the way private actors do, by raising demand for it.
If things I want to buy or normally buy get more expensive I either change what I buy, decrease total consumption, draw down savings, go into debt, or find a way to increase my income (aka start producing more or better value for sale in the labor market). Everyone else doing the same gradually shifts the patterns of consumption and production. Hopefully in ways that increase long-term productive capacity. Repeat forever. The whole edifice of finance and business and the relevant branches of law are built to facilitate this.
Interest rates are kind of a weird tool to use to affect the money supply, because it’s hard to know at any given moment what level they need to be above or below to actually decrease or increase the amount of money in circulation (which IIUC is one of the arguments in favor of switching to NGDP level targeting), but basically that’s the idea. Money gets created when the Fed lends it into existence, to the Treasury or to banks. It goes into circulation when banks lend it out or the Treasury spends it, and leaves circulation when the Fed gets paid back.
Interest rates are the price of money, and the higher the price of money, the lower the amount of money people and governments can borrow and want to borrow. A house’s list price looks a lot more attractive with a 5% mortgage than a 10% mortgage, so if mortgage rates go up, house prices go down until people buy them, or they don’t get sold at all. In a well-functioning market, builders then build fewer new houses because they can’t get as high a price for them. A factory that wants to buy a capex-heavy system to increase output might do it if they can pay it back at 5% interest over 10 years, but the output increase may not be worth it if you have to pay 10%.
(And if you’re also wondering how the heck the IRA is supposed to fight inflation with lots of subsidies, it’s industrial policy, an attempt to increase productive capacity by lowering the price of investing in things that let us make more and better stuff that we want people to make more and better of. This is a long-term strategy whose effects would show up over years, and IMO too many countries have been neglecting industrial policy needs for a long time.)
That’s the part of the story that I feel I get well enough. However this story abstracts over what things you would buy, what you’d use those things for, etc.. It’s essentially still a story of finance, but with a different focus. What I’m wondering about is the dual side of the picture.
Like for instance you mention the builders deciding to build fewer houses as a result of the interest rates. Is that because construction workers are sitting around looking at interests rates changes/housing price changes and deciding based on that? I don’t think so, because I don’t think the construction workers have the capital to build houses. I think there’s probably a bunch of channels in the economy where the information trickles through, e.g. maybe someone in a company that needs stuff built so they can rent it out asks the bank for loans and then finds that the loans have become more expensive. However I don’t feel I have a conprehensive picture of what the exact interactions would look like.
I’m not sure a single human brain can hold that comprehensive of a picture at once? If it could we wouldn’t need all those channels. The whole point of markets is that they make that process work mostly invisibly to each of us.
For the house example, if I’m a buyer my budget usually isn’t something like “$500,000.” It’s more like “$100,000 plus $2500/month.” Depending on loan terms that could mean a $600k house or a $300k house. The seller determines the listing price, but the buyer decides whether to bid. So a general change in loan terms across the population can mean I bid on the same house at up to $300k or up to $600k. Which, in turn, means that as interest rates go up, sellers drop the price to get a sale at all, or get a sale in a reasonable timeframe. Even if I’m a builder and nothing affects the builders costs at all and the production cost stays fixed at $200k, I’m going to be a lot more aggressive about hiring more crews and buying supplies and equipment if I can net $400k per house rather than $100k per house. It’s less risky: If the successful projects have a 200% ROI instead of 50% ROI, I can afford to borrow to finance up-front expenses for more projects at once (relative to my existing assets) without worrying about paying them back even when some of my projects fall through. In practice, it’s a bigger effect than that, because lower borrowing costs for homeowners tend to also correlate with lower borrowing cost for builders. Also because the same effects ripple through from the earlier parts of the value chain, affecting borrowing, hiring, and scale-up costs in mining, forestry, metallurgy, factories making machines and tools, factories making parts and semi-finished materials, all of it. Alternatively, or concurrently, if people can afford to pay more because of loan terms, a builder may decide to build bigger and more luxurious houses if that gets them better returns. Plus, existing homeowners are more likely to renovate and hire contractors when they can finance it cheaply while they get a windfall in the form of home equity as the market price grows.
(This is a reasonable comment and an appropriate answer to the question in the OP. I happen to already know this, so it’s not so interesting to me, but it might be interesting to other people. I am more interested in, what are the concrete types of tasks, decisions, constraints, environments, interactions, etc. that happen in the economy. Which can involve coordination tasks, but not just coordination tasks. That said, I don’t mind this big picture/theoretical comment. Just giving hints for what I am personally looking for.)
A slightly less abstract summary is “assigning scare resources”.
Imagine that you are a world dictator, and to keep things simple, you want to build an agrarian utopia. However, instead of Pol Pot, you are actually not an evil guy, and you genuinely want people to live happily and have enough food.
Okay, so you have a certain budget each year. Or, to remove the complications of using money, you have a certain amount of resources (including man-days) that you can spend during that year. How much will you (make your subjects) spend, assuming that they are 100% obedient, so no need to actually spend most money on your personal security...
literally digging in the garden (manually, or using a machine)
drilling and refining oil for the machine
mining the iron for the machine
researching a better type of machine
transporting food from place A to place B
oil / iron / research for the transporting machines
or maybe you should instead resettle people from place B to place A
building the new houses
...it gets complicated quickly. And the more you think about, the more complicated it gets. For example, you still need some form of education, even if it is “narrowly” focused on agricultural work, iron machine design, construction, etc.
One part of the “economy” is that these things often just happen, by random people finding their personal motivation (often profit) to research them, do them, and maybe suffer a personal loss if their guess was wrong.
IDK if it’s historically true, but I’ve read that the origin of coinage was to make it possible for governments to automate the provisioning of their armies. Instead of directly controlling it all, you mint coins, give them to soldiers, tell the soldiers what they’re responsible for, and make a law that every citizen has to pay a certain amount of those coins in taxes each year. Directly or indirectly, everyone has to do something to benefit the soldiers in order to get those coins.
Indeed. And this is actually another angle through which I encountered the question in the OP. Sometimes the government tries to control the economy by changing the properties of money, e.g. changing the central bank rates in order to cause inflation. But I would like to get a better mechanistic understanding of which decisions shift in response to the interest rates. I think I kind of get the dynamics within finance, but finance is very abstracted from the object level.
Ok, then if we set finance aside, we’re left with a set of resources that can be used for all sorts of purposes. Minerals, land, plants, animals, equipment, people, skills, knowledge, etc.
Then some entity creates some form of money, and we all agree to use it as the unity of account and medium of exchange and store of value. That can happen in different ways, like the one I mentioned in the previous comment. At this point, people want money because money is the tool that lets them get other things that have value to them.
People start producing things of their choice and selling them for a price of their choice. By this process they learn, individually and collectively, what prices other people are willing to pay. Scale it up and we get market prices and efficient markets for goods and services. Everything has a price relative to everything else. That price changes over time for all sorts of reasons.
The government can manipulate the overall level of prices, aka inflation and deflation, by altering the amount of money in circulation: unless we increase our productive capacity or decrease consumption, more money chasing the same goods and services means prices go up. It can also change relative prices through selective taxes and subsidies. Or by purchasing stuff, which affects prices the way private actors do, by raising demand for it.
If things I want to buy or normally buy get more expensive I either change what I buy, decrease total consumption, draw down savings, go into debt, or find a way to increase my income (aka start producing more or better value for sale in the labor market). Everyone else doing the same gradually shifts the patterns of consumption and production. Hopefully in ways that increase long-term productive capacity. Repeat forever. The whole edifice of finance and business and the relevant branches of law are built to facilitate this.
Interest rates are kind of a weird tool to use to affect the money supply, because it’s hard to know at any given moment what level they need to be above or below to actually decrease or increase the amount of money in circulation (which IIUC is one of the arguments in favor of switching to NGDP level targeting), but basically that’s the idea. Money gets created when the Fed lends it into existence, to the Treasury or to banks. It goes into circulation when banks lend it out or the Treasury spends it, and leaves circulation when the Fed gets paid back.
Interest rates are the price of money, and the higher the price of money, the lower the amount of money people and governments can borrow and want to borrow. A house’s list price looks a lot more attractive with a 5% mortgage than a 10% mortgage, so if mortgage rates go up, house prices go down until people buy them, or they don’t get sold at all. In a well-functioning market, builders then build fewer new houses because they can’t get as high a price for them. A factory that wants to buy a capex-heavy system to increase output might do it if they can pay it back at 5% interest over 10 years, but the output increase may not be worth it if you have to pay 10%.
(And if you’re also wondering how the heck the IRA is supposed to fight inflation with lots of subsidies, it’s industrial policy, an attempt to increase productive capacity by lowering the price of investing in things that let us make more and better stuff that we want people to make more and better of. This is a long-term strategy whose effects would show up over years, and IMO too many countries have been neglecting industrial policy needs for a long time.)
That’s the part of the story that I feel I get well enough. However this story abstracts over what things you would buy, what you’d use those things for, etc.. It’s essentially still a story of finance, but with a different focus. What I’m wondering about is the dual side of the picture.
Like for instance you mention the builders deciding to build fewer houses as a result of the interest rates. Is that because construction workers are sitting around looking at interests rates changes/housing price changes and deciding based on that? I don’t think so, because I don’t think the construction workers have the capital to build houses. I think there’s probably a bunch of channels in the economy where the information trickles through, e.g. maybe someone in a company that needs stuff built so they can rent it out asks the bank for loans and then finds that the loans have become more expensive. However I don’t feel I have a conprehensive picture of what the exact interactions would look like.
I’m not sure a single human brain can hold that comprehensive of a picture at once? If it could we wouldn’t need all those channels. The whole point of markets is that they make that process work mostly invisibly to each of us.
For the house example, if I’m a buyer my budget usually isn’t something like “$500,000.” It’s more like “$100,000 plus $2500/month.” Depending on loan terms that could mean a $600k house or a $300k house. The seller determines the listing price, but the buyer decides whether to bid. So a general change in loan terms across the population can mean I bid on the same house at up to $300k or up to $600k. Which, in turn, means that as interest rates go up, sellers drop the price to get a sale at all, or get a sale in a reasonable timeframe. Even if I’m a builder and nothing affects the builders costs at all and the production cost stays fixed at $200k, I’m going to be a lot more aggressive about hiring more crews and buying supplies and equipment if I can net $400k per house rather than $100k per house. It’s less risky: If the successful projects have a 200% ROI instead of 50% ROI, I can afford to borrow to finance up-front expenses for more projects at once (relative to my existing assets) without worrying about paying them back even when some of my projects fall through. In practice, it’s a bigger effect than that, because lower borrowing costs for homeowners tend to also correlate with lower borrowing cost for builders. Also because the same effects ripple through from the earlier parts of the value chain, affecting borrowing, hiring, and scale-up costs in mining, forestry, metallurgy, factories making machines and tools, factories making parts and semi-finished materials, all of it. Alternatively, or concurrently, if people can afford to pay more because of loan terms, a builder may decide to build bigger and more luxurious houses if that gets them better returns. Plus, existing homeowners are more likely to renovate and hire contractors when they can finance it cheaply while they get a windfall in the form of home equity as the market price grows.
Probably not, but if I try anyway I might still get a better understanding of some things.
(This is a reasonable comment and an appropriate answer to the question in the OP. I happen to already know this, so it’s not so interesting to me, but it might be interesting to other people. I am more interested in, what are the concrete types of tasks, decisions, constraints, environments, interactions, etc. that happen in the economy. Which can involve coordination tasks, but not just coordination tasks. That said, I don’t mind this big picture/theoretical comment. Just giving hints for what I am personally looking for.)