Hi there,
As I was writing an essay about common misconceptions concerning inflation, I came across a dilemma of sorts.
As you know, most of the money in circulation, is equivalent to debt. As more money is required, more is simply made out of thin air (FRB). So the theory goes that as the quantity of money increases, its value (purchasing power) falls, and so we have inflation. However, I just thought of something I hadn't thought of before. If money is equated to debt, and more money is created because people borrow more, then together with the supply of money, the demand for it also increases. Indeed, the demand pull for money leads the supply of it, causing a new equilibrium to be reached where more money isfloating around, but with greater demand, so the purchasing power remains.
What am I missing here? Is is that when people can no longer pay off their debts and the credit-driven boom ends in a bust, that demand for money falls and suddenly we have inflation? In which case, is inflation not always a direct and immediate consequence of monetary expansion?
Thanks in advance for any answers.
a few thoughts:
1. money is never in "circulation". it is always held by somebody.
2. money is first and foremost a medium of exchange. so when more money is printed, given the value scales of the individuals in the economy, people find that they have more money than they demand. so they spend the excess...thereby driving up prices and leading to a fall in the value of money.
3. money IS NOT debt...it cannot be equated to debt. money is a medium of exchange....a good that is demanded because of its universal acceptability in a given economy. changes in the demand for money need not lead to changes in the supply. in an economy with a fiat currency and a central bank, if the supply of money accomodates itself to the changes in its demand, the purchasing power of money need not remain unchanged because such changes are non-neutral.
4. plus, these injections of fresh money is what causes the boom-bust cycle.
sorry...my previous post was hurried...this one is better thought out:
1. money is never in "circulation" but is always held by somebody. all the money in the economy must be held by somebody or the other.
2. money is first and foremost a medium of exchange, a good that is demanded because of its near universal acceptability in a given market. when the supply of money increases, given the demand for money by the individuals in the economy, people find that they have more cash than they want and spend the excess...thereby leading to a rise on prices.
3. any change in either the demand or the supply of money is non-neutral, i.e., it leads to a greater price change for some goods than for others. this follows from the fact that it is INDIVIDUALS who demand and spend money. if the change in prices caused by a change in the demand or supply of money were neutral, then a change in one would cancel out the other. but given non-neutrality, this doesn't happen. a change in the demand for money might affect the prices of goods in the market in a different way as compared to a change in the supply of money happening simultaneously.
4. money is NOT DEBT. debt or credit is real, not monetary. in a modern economy all debt consists IN MONEY but IS NOT MONEY. when individuals demand more debt, they are demanding more capital, i.e., money which has been saved. capital cannot be produced out of thin air by printing out money.
hope this helps!
Fred Furash: However, I just thought of something I hadn't thought of before. If money is equated to debt, and more money is created because people borrow more, then together with the supply of money, the demand for it also increases. Indeed, the demand pull for money leads the supply of it, causing a new equilibrium to be reached where more money isfloating around, but with greater demand, so the purchasing power remains.
Although my knowlage of English is poor I will try to explain what I think of this problem. I hope you won't miss the point. ;-)
First of all we must distinguish between demand for money and demand for investable resources (or loanable founds). These are two different economic categories. When we talk about demand for money we mean the demand of any individual who wants to sell goods or services and "buy" money. Demand for loanable founds is called at financial markets. It doesn't depend on how much goods people are going to sell but how much savings sociaty have got available. Availability of loanable founds depends on social time preference that constitute interest. The lower real interest rates are the "cheaper" credit is.
You wrote:
Fred Furash:As more money is required
It isn't "more money" but more lounable funds or investable resoruces. It's increasing demand for real things, real resources not money. Banks can create more deposit money because of fractional reserve system but they can't create more real resources. Boom / bust cycle is not driven by inflation. Inflation may by caused by printing money and giving it to public for nothing but this won't cause malinvestments.
I'm still not sure about this. As you say, money is not an end in itself, but merely a medium of exchange. In which case, as demand for goods and services rises, will not more money be necessary? Or can the demand for goods and services increase while keeping within the current amount of money supply? Note that when I say demand for goods and services, I mean debt-based demand. In other words, the amount of loans demanded will increase, so more money will have to be created. Why? Because not enough people save, and the amount of people requiring loans is far larger than those that save their money and are willing to provide these loans.
Could you please explain in more detail what you mean when debt consists of money but is not money. Does not the fact itself that debt consisting of money increase the money supply as debt rises, and hence cause inflation? Even if the real debt is an IOU with collateral, this still needs to be represented by money, so more money needs to be created, diluting the supply and causing inflation.
I think I've confused myself lol.
Or maybe if I word it as an example it might make more sense. Say I want a mortgage to buy a house. What I really want is the house, not the money necessary to buy it. When a bank provides me with a mortgage, I never see the money, it's simply wired to the account of the person selling the house. In which case demand has not been created on my side, but on the side of the person selling me the house. He has exchanged his house for money, which wasn't in the economy before. Of course, he'll never see that money either. It will be deposited in his account and later exchanged for something he wants to buy. Is this what is meant when you say that the demand for money has not increased, only it's supply?
Fred Furash:In which case, as demand for goods and services rises, will not more money be necessary? Or can the demand for goods and services increase while keeping within the current amount of money supply? Note that when I say demand for goods and services, I mean debt-based demand.
I assume that when you say debt-based demand you think of demand for credit (loanable founds). When people demand more credit interest rates go up. This is a signal for people to save more . So you can see that additional ammount of money is not necessary to operate transactions. I am going to say more. We must not increase supply of money through credit if we want to have undisturbed credit market. All loans should be financed by real savings not by money creation.
Fred Furash:In other words, the amount of loans demanded will increase, so more money will have to be created. Why? Because not enough people save, and the amount of people requiring loans is far larger than those that save their money and are willing to provide these loans.
More money won't have to be created. As I mentioned. Interest rates will go up and people will save more. It's enough to stabilize the market. Additional ammount of money created by the bank system makes the coordination process of establishing market rates as good as possible disturbed.
Fred Furash:Is this what is meant when you say that the demand for money has not increased, only it's supply?
Yes, this is. Demand for money is increasing only when people want to sell more goods.
I hope I have helped you a little, good luck. ;-)
Yaros:I assume that when you say debt-based demand you think of demand for credit (loanable founds). When people demand more credit interest rates go up. This is a signal for people to save more . So you can see that additional ammount of money is not necessary to operate transactions. I am going to say more. We must not increase supply of money through credit if we want to have undisturbed credit market. All loans should be financed by real savings not by money creation.
Yes I understand that.
That's what is supposed to happen, but it doesn't. Interest rates aren't allowed to reach their market level equilibrium, instead they are adjusted by central banks (Fed, BOE, ECB). So if interests rates aren't allowed to rise, an increase in the demand for money is hence met by more money being created through fractional reserve banking. I know why this system is bad, how it causes the boom/bust cycle, and how to solve the problem. For the purposes of my question I was assuming that we live in the current economic climate of debt-based growth.
Of course, if we allow the free market to do the job of finding a perfect equilibrium between savers and lenders through interest rates, then there would never be a need to create debt-based money.
Yaros:Demand for money is increasing only when people want to sell more goods.
Demand for money is increasing only when people want to sell more goods.
Right, that's where my mistake was. So it is the supply of goods, and not the demand for them that directly increases the demand for money. Demand for goods in itself has only indirect effects, which never materialise without supply rising with demand. In other words, I might want to buy your banana, but if you think my dollar is worth less than a banana,you won't sell it, sothe demand for money isn't there.
Thanks for clarifying :)
P.S. Your English seems fine to me!
i think yaros cleared things up for you...ya and his english seems fine to me too!...just wanted to say that regardsless of whether there exists a central bank or not, capital is capital and money is money...the nature of these things cannot change...in fact that is precisely why the central banking system is so harmful...cos it dishes out fresh money in place of savings and capital...and there can never be a "need" to create debt-based money...it of course can be done...but it messes up the entire capital-goods structure of the economy...