EKIP– Expert Club for Economics and Politics A Different Opinion
Author: Frank Shostak, Mises.org
The idea that more money can boost the economy is based on the belief that money has a stimulatory effect by increasing aggregate spending. More money in people's pockets means they can spend more, and the rest follows from that. Money, in this sense, is a means of payment and financing.
But in reality, money is not a means of payment, but of exchange. It simply allows one producer of value to exchange his production for that of another. The means of payment are the actual goods and services that we provide to pay for other goods and services. Money simply facilitates this payment, it makes it practically possible.
For example, a baker exchanges his bread for money and then uses that money to buy shoes. He pays for the shoes not with money but with the bread he has produced. Money simply allows him to carry out this transaction. (The production of bread is also the source of the baker's demand for money.)
On this subject, Mises writes in "Human Action" that
"The services that money provides depend on the level of its purchasing value. No one seeks to hold a certain amount of money with a certain weight, etc.; everyone wants to hold money with a certain purchasing value."
In a free market, the price of money is determined by supply and demand, just like the price of other goods. If there is less money, its purchasing value will rise. Conversely, if more money becomes available, its purchasing value will fall. In a free market, there can be no "too little" or "too much" money. As long as the market operates undisturbed, there can be no shortage of money.
Once the market has chosen a particular commodity as money, the corresponding supply of that commodity will always be sufficient (whatever it may be) to perform the function of a medium of exchange. Accordingly, in a free market, the idea that there is such a thing as an "optimal" level of growth of the money supply is absurd. Again according to Mises:
"Because the functioning of the market determines the ultimate level of purchasing power of money where the demand for and supply of money meet, there can never be a surplus or a deficit of money. Each individual and all individuals together always benefit from all the benefits that they can derive from the indirect exchange and use of money, no matter how small or large the quantity of monetary units is...the work that money does cannot be improved by a change in the supply of money...The amount of money available in the entire economy is always sufficient to provide all the necessary functions of a medium of exchange for everyone."
In a market economy, the purpose of production is consumption. People produce and exchange the produced goods and services to improve their lives – this is the ultimate goal. This means that consumption cannot exist without production, and production without consumption is meaningless. Accordingly, in a free market economy, production and consumption are in harmony. In a natural market economy, consumption is based entirely on production.
What allows the baker to consume bread and shoes is his production of bread. Part of the bread goes directly to his consumption (by him) while another part is used to pay (indirectly) for the shoes. His consumption is fully supported (i.e. paid for) by his production. Any attempt to increase consumption without a corresponding increase in production leads to inflated consumption at someone else's expense.
That's exactly what pumping money into the economy does. It generates demand for consumption that is not based on production. When it occurs, it sabotages the flow of real savings and weakens real capital formation, thus slowing down rather than stimulating economic growth.
Real savings, not money, are the means that allow the production of more and better tools and machines. With more and better quality capital, it is possible to increase the production of final goods and services - this is what economic growth is.
The true source of wealth
Contrary to popular belief, creating artificial consumption (without production behind it) by pumping money can only worsen economic growth. This is because this type of consumption weakens the flow of real savings and thus drains the source of real economic growth. If it were otherwise, world poverty would have been eliminated long ago. After all, everyone knows how to consume. The only reason monetary policy can seem to lead to growth is because the level of real savings formation is high enough to absorb the artificial inflation of consumption.
However, when the level of artificial consumption reaches a level where the flow of real savings completely disappears, the economy falls into crisis. Any attempt by the central bank to get the economy out of crisis by pumping more money makes things worse, because it not only supports artificial and unproductive consumption, but also because it destroys what is left of real savings (through inflation).
In this situation, banks will most likely only lend to customers with the highest credit ratings. However, as the economic crisis deepens, it becomes much more difficult to find such customers. Moreover, due to loose monetary policy, the resulting lower interest rates, in the context of higher economic risk, further reduces the willingness of banks to lend. All this pushes the money supply in the economy down, causing it to shrink.
And so the central bank sees that despite its attempts to create inflationary growth, the money supply is starting to fall. Obviously, the central bank could counteract this by printing money even more aggressively. It could also monetize the government's budget deficit. It could send checks to every single citizen. But all of this would only further erode real savings and destroy the real economy.
