Brief introduction of central banks
Central banks play a crucial role in maintaining the stability of a country's economy. They are responsible for setting monetary policies, controlling the supply of money, and regulating financial institutions. However, in recent years, central banks have come under criticism for their actions and their impact on the economy, particularly on those with low incomes.
Their role in the global economy is without a doubt, a highly controversial topic that generates a lot of debate and discussion. One of the main issues with central banks is the practice of fractional reserve banking. While this system does have its benefits, it can also result in problems for people who are not as financially fortunate. We will explore the issue with central banks, how fractional reserve banking results in inflation, and provide some ways for people to combat it. Which if we look around today with the high cost of living crisis, is ever so important.
So what is fractional reserve banking?
It's a system where banks are required to hold only a fraction of their deposits in reserve and can loan out the rest. To put it simply, they hold that fraction of the deposit in order to fulfil any withdrawal requests you might have. They don’t hold the full amount simply because the chance that someone will request all their money all at once from their bank, is low.
Then with the remaining amount of money, banks use it to give out to other people in the form of loans. That person will likely deposit their loaned money into another bank, who will likely also use the practice of fractional reserve banking, keeping a small portion of their deposit, then loaning it out again, creating a cycle.
So, what ends up happening, is the amount originally deposited is vastly smaller than the amount of money in total in the monetary system.
An increase in the money supply, which can stimulate economic growth by facilitating lending and investment. However, when the money supply grows faster than the production of goods and services, it leads to inflation, reducing the value of money.
Inflation is the overall increase in prices over time, eroding the purchasing power of money. This is a particular problem for low-income households, as they often suffer the most from inflation.
When prices go up, people have low spending power, meaning they must prioritise more of their income on necessities like food, housing and heating. We see this alarmingly frequent today in the UK, with:
So what can we do to combat inflation? Here's six ways you can protect yourself:
1. Cut unnecessary spending and increase purchasing power.
This can be done by finding ways to lower your cost of living, such as buying the best deals on necessities like food and clothing. Use discounts, coupons, and take advantage of sales to stretch the value of whatever currency you have, further. Additionally, buying in bulk, growing your own food, and seeking out generic or store-brand products rather than luxury items, can also help reduce the overall cost of living.
2. Look for additional revenue streams,
E.g., taking a part-time job or finding new sources of income through investments or other ventures. One of the best ways to protect yourself from inflation is to have a diversified investment portfolio. That means you should consider investing in a variety of assets, such as stocks, bonds, and real estate, rather than keeping all your savings in cash.
Setting up an Individuals Savings Account (ISA) is vital, as it provides a way for you to get tax free returns on your investments. It should be advised that with investments, it’s important to seek professional advice when considering it, as they can come with significant risks as well. However, they do offer the possibility of also providing higher returns in the long run and can protect against inflation.
Creating and sticking to a budget can help people stay on top of their finances and make the most of their resources. This involves tracking your spending, identifying areas where you can cut back, and prioritizing spending on the essentials.
4. Reducing high interest debt:
Debt can be a significant burden for people of low incomes, particularly when inflation is driving up the cost of living. But by reducing debt, people can free up resources to meet their basic needs and prepare for unexpected expenses.
5. Create an emergency fund:
Having an emergency fund can provide a financial safety net in case of unexpected expenses or job loss. Typically you should aim to save at least three months of income, to help provide a cushion against the effects of inflation and any financial uncertainty.
6. Keep in touch with financial news
It is vital to keep pace with changes in the economy and the actions of central banks. Staying informed about economic trends and changes in interest rates can help you to make more informed decisions about your finances and investments. Which helps to minimize the impact of inflation and helps you claim back that purchasing power that you deserve.
Inflation can have a devastating impact on most people, as most of us aren’t financially well off, and we struggle to make ends meet in an increasingly expensive world. The actions of central banks, particularly the practice of fractional reserve banking, can contribute to this problem. While inflation is a challenge, with the right strategies, it does certainly help with staying afloat against the tide of financial crisis that is daunting to us all.