10 - Money, Credit, and the Economy

Abstract

This chapter describes money, credit, and the economy. In general, money can be raised either through the sale of debt or through the sale of equity. Shares of stock represent partial ownership in a firm and have value because they carry with them the right to receive dividends. Bonds and other debt instruments, issued by both firms and governments, represent a promise of future repayment. The demand for credit is affected by the level of the interest rate, income, inflation rates, inflation expectations, and governmental policies that affect borrowing. Interest rates are set through the interaction of borrowers and lenders on the credit market. Factors that cause a change in either the supply of credit or the demand for it would change the interest rate. Disintermediation occurs when interest rates rise above the legal maximums that financial intermediaries might pay. Money is then withdrawn from these financial institutions and is invested directly in credit markets, resulting in an increase in credit availability there but a reduction in credit available through banks and financial institutions.