Summary
The currency is government-issued and authorized by government regulation, serving as legal tender. The use of fiat currencies is mandated or forced (decreed) upon the population, even though the value is an illusion.
Here’s how it works:
https://www.youtube.com/watch?v=CFSr7vgaKlU
https://www.investopedia.com/terms/f/fiatmoney.asp
https://en.wikipedia.org/wiki/Fiat_money
https://corporatefinanceinstitute.com/resources/economics/fiat-money-currency/
1. Inflation Basics
- Inflation is the general rise in prices over time, reducing the purchasing power of money.
- It occurs when demand exceeds supply (demand-pull inflation) or when production costs rise (cost-push inflation).
2. Fiat Currency and Money Supply
- Central banks, with the authority to create more currency at will, wield significant power in the economy due to the nature of fiat money not being tied to a physical commodity.
- Expansionary monetary policy (printing money or lowering interest rates) increases the money supply, which can stimulate economic growth but also risks inflation if overdone.
3. Mechanism of Inflation with Fiat Money
- More Money, Same Goods: If the money supply grows faster than the economy’s output, prices rise.
- The influence of expectations on inflation is a key psychological factor. When people anticipate inflation, they tend to spend faster, thereby accelerating price increases.
- Hyperinflation Risk: Extreme overprinting (e.g., Zimbabwe, Venezuela) can destroy currency value.
4. Central Bank Role
- Inflation Targeting: Most central banks aim for ~2% annual inflation.
- Tools: Adjusting interest rates, open market operations, and reserving requirements to control liquidity.
5. Why Fiat Systems Are Vulnerable
- Unlike gold-backed systems, there’s no natural limit on money creation.
- Political pressure can lead to monetary mismanagement, especially during crises.