ABCT holds that business cycles are caused by an increase in the supply of money. I understand the supply part of ABCT pretty well, but I do not understand how demand factors in.
For example, wouldn't the decrease in the demand for money also cause business cycles? Why such a decrease not result in economic problems? What about an increase in demand? Both must affect the price of money just as supply does.
Also, another question about how money can be demanded. Goods are demanded with money, or other goods in a barter economy, if I am not mistaken. For example, I may want to buy a candy bar, but that is want, not demand. I have to supply something to demand with. When people talk about demanding money, I get confused. If one is holding cash, it is said they have a higher demand for money. How? What are they demanding that money with?
Maybe these are trivial questions. But when it comes to money and demand, I get lost.
Demand for money has a special meaning, not the same as demand for cars. By definition, it means the desire to keep money under the mattress, and neither spend it nor put in the bank [=invest it].
It is amenable to supply and demand curves, if by supply of money is meant the amount that people are not spending on consumption, and if "price" of money is meant the interest rate. The higher the price, meaning the greater the interest rate offered for money, the less the demand, meaning the less people will hide it under the mattress, because they want the high interest.
In some discussions, the price of money means something totally different, mainly it's value, meaning what you can buy with it. If at a given moment in a given place a dollar can buy 3 oranges or 4 apples etc etc, then the price of a dollar is defined as three oranges or four appples or etc etc.
This is a deep deep question. Here is my take on it.
If new money is not created, then how does one make money? By working. In other words, you only have money in the first place if you have produced something worthwhile. After you have done your share, being productive, then you get money, which allows you to go out there and reap the rewards of your productivity, by consuming what you want. Before you ever got the money, you have contributed.
In short, having a dollar in your wallet is at once a Certificate of Productivity and a License to Consume. Your consumption will not reduce the wealth of the nation that existed before you were born, because you have already increased the wealth before you ever took any for yourself.
But what happens if the supply of money is increased? This means, in practice, that the govt prints new money for itself, either paper money or digital money. They are giving themselves a License to Consume with that new money, but it certainly is not a Certificate of Productivity. They did not contribute anything to the economy to get that money; they just printed it up for themselves.
ABCT explains booms and busts in this way. When the entrepeneur sees so much money floating around, he assumes mistakenly that it represents an increase in valid Certificates of Production. In other words, so much has been produced, apparently, there is a large [and therefore cheap] supply of all the stuff he needs to expand his business. So he starts expanding, using up the resources that are around, thinking there is plenty for everyone. You know the rest.
An increase or decrease in the demand for money, no matter how it is defined, does not create new Licences to Spend. That's why it doesn't create a business cycle.
Now there are some who make the argument that hoarding money will produce changes in what is produced. Which is correct. But they then make the absurd claim that these changes are "distortions", when they are but effects of changing consumer needs. Nobody would call the end of some fad a "distortion". A decision on the part of consumers to spend or not to spend for a while is the heart of the market process, not a distortion of it.
The only true distortion of a market is the granting of a License to Spend to someone who does not have a Certificate of Production. That's why counterfeiting, armed robbery, extortion, fraud, and other crimes are considered distortions of the market [and destructive of it]. Same with money printing.
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It's easy to refute an argument if you first misrepresent it. William Keizer
An increase in the supply of money per se doesn't cause the business cycle, only when channeled through the loan market supressing the market rate of interest causing it to diverge from the natural rate.
A change in the demand for money could mean several things, so you have to use the term with a bit of precision. For any good (including money), there is both exchange demand and reservation demand.
In this context you're referring to the reservation demand for money, i.e. demand to hold money in cash balances. In order to know the effect of this and assuming we're talking about a higher/increased reservation demand, you have to know whether this demand comes about by lowering consumption expenditures, lowering saving (i.e. not making your money available for loans), or leaving your saving/consumption ratio unchanged by drawing down both.
The former signifies decreased time preference and will lower the rate of interest (sustainably) thus lengthening the capital structure (though less drastically than if the funds from decreased consumption had gone directly to savings, which would have lowered the interest rate further, rather than to cash balances). The second scenario would have the opposite effect. The latter would leave time preference unchanged and thus interest rates would be unaffected and the market would tend to a new equilibrium with a higher PPM (purchasing power of money), or conversely, a lower level of prices.
A lower/decreased reservation demand for money will cause people to hold less cash balances and they can do that by either increasing consumption, increasing savings, or leaving the savings/consumption ratio unchanged and the effects will be the opposite of their corollaries above.
"Also, another question about how money can be demanded. Goods are demanded with money, or other goods in a barter economy, if I am not mistaken. For example, I may want to buy a candy bar, but that is want, not demand. I have to supply something to demand with. When people talk about demanding money, I get confused. If one is holding cash, it is said they have a higher demand for money. How? What are they demanding that money with?"
The type of demand you're thinking of for goods is their exchange demand. There is also an exchange demand for money and it is simply the logical flipside of the exhange demand for goods. If the exchange demand for goods rises, their money-price will rise (people will bid higher prices by offering more money). If the exchange demand for money rises, its goods-price will increase (meaning more goods will be offered for the same amount of money) which means the money-prices of goods exhanging against money will come down. I'm probably being a bit redundant but (obviously if goods have a money-price, they are exchanging against money), but I'm just trying to be as thorough as possible.
Now for reservation demand, it might help to think of it like this: the demander owns some good and has some minimum price below which they will not part with that good (unless the good in question is invaluable to its owner, in which case they won't part with it at all). The same is true with money. The mininum price when the good is money can be some minimum interest return, or some maximum money-price of certain goods (thus a minimum purchasing power for the money in the actor's cash balances).
Hope that helps.