The Importance of Money in the Economy
Introduction:
Many economic commentators believe that increasing the quantity of money can revive an economy. They argue that with more money in circulation, people will spend more, leading to a chain reaction of increased spending. However, this perspective overlooks the true nature of money and its role in the economy. Money is not the means of payment but rather a medium of exchange. It facilitates transactions between producers and enables the exchange of goods and services. In order to fully understand the impact of money on the economy, it is important to delve deeper into its functions and examine the relationship between money and purchasing power.
Money as a Medium of Exchange:
According to Murray Rothbard, money per se is unproductive. It cannot be consumed or used directly in the production process. Instead, it serves as a medium of exchange, allowing producers to trade their products for the goods and services they need. For example, a baker produces bread and exchanges it for money, which he then uses to purchase shoes. The baker’s production of bread generates his demand for money, as it is the most marketable commodity. Money simply facilitates the payment for goods and services in the market.
Demand for Purchasing Power:
People do not desire money itself; they desire its purchasing power. Ludwig von Mises argues that individuals want to hold a certain amount of purchasing power in their cash holdings. A decline in the supply of money, all other things being equal, strengthens the purchasing power of money. Conversely, an increase in the quantity of money leads to a decline in its purchasing power. Therefore, it is incorrect to believe that there can be “too little” or “too much” money, as long as the market is allowed to clear. The quantity of money available in the economy is always sufficient to fulfill the demands for goods and services.
Production and Consumption:
The ultimate purpose of production is consumption. People produce goods and services to improve their well-being and satisfy their needs. In a free-market economy, consumption and production are in harmony with each other, as consumption is backed by production. The baker’s consumption of bread is fully supported by his production of bread. Any attempt to increase consumption without a corresponding increase in production leads to unbacked consumption, which comes at the expense of others.
The Dangers of Monetary Pumping:
Monetary pumping, or the increase in the money supply, generates demand that is not supported by production. This type of demand undermines real savings and disrupts the formation of capital, weakening economic growth. It is real savings, not money, that funds the production of better tools and machinery, leading to increased productivity and the production of consumer goods and services.
Contrary to popular belief, setting in motion consumption unbacked by production through monetary pumping stifles economic growth. Unbacked consumption diminishes the flow of real savings, which is essential for sustainable economic development. Attempts by central banks to stimulate the economy through monetary pumping only exacerbate the problem, depleting real savings and destabilizing businesses.
The Role of Bank Lending:
In an economic slump, banks become more cautious with their lending practices. The collapse in the source of economic growth exposes banks’ fractional reserve lending and raises the risk of bank runs. To protect themselves, banks curtail the generation of credit from “thin air.” This further decreases lending and hampers economic recovery.
The Illusion of Increased Demand:
Mainstream economists argue that an increase in the money supply will lead to increased demand for consumer goods and services, spurring economic growth. However, this perspective fails to consider the importance of a suitable infrastructure to accommodate increased production. Without sufficient real savings to support the creation of infrastructure, economic growth cannot be sustained. Increasing the money supply only undermines the formation of real savings and delays, rather than promotes, economic recovery.
Conclusion:
Contrary to popular belief, increasing the quantity of money does not strengthen economic growth. Money serves as a medium of exchange and cannot directly stimulate the economy. Instead, it is the formation of real savings and productive investments that drive sustainable economic development. By understanding the true role of money and its relationship with production and consumption, we can better comprehend the complexities of the economy and work towards fostering long-term growth.
