The prevalent belief among economic commentators is that during challenging economic times, the central bank should intervene by increasing the money supply to support the economy. This is thought to boost economic growth by stimulating individuals’ demand for goods and services.
According to this perspective, economic activity is described as a “circular flow” of money. When one individual spends money, it becomes income for another individual, who then spends it, creating a cycle. If one person spends less, it affects others, leading to reduced spending overall.
To prevent a recession from worsening, the central bank is advised to inject more money into the economy to make up for the shortfall in private sector spending. With more money in circulation, individuals are expected to increase their spending on goods and services, thereby boosting demand and production. Once this circular flow is restored, economic growth is anticipated to resume.
In reality, wealth generators in a market economy do not consume everything they produce. They exchange part of their production for goods and services from others. This exchange is based on the production of goods preceding consumption. Increased production leads to higher demand for goods and services, as supply creates demand. Money is only a means of facilitating transactions; individuals ultimately pay for goods and services with other goods and services, highlighting the importance of production in driving economic growth.
Contrary to popular belief, simply increasing demand through monetary inflation does not spur true economic growth. It may temporarily boost economic activity but at the expense of undermining production, savings, and investment. Sustainable economic growth is driven by production, saving, and investment in capital, such as improved tools and machinery that enhance productivity and efficiency.
Inflating the money supply to stimulate demand without corresponding increases in production can have detrimental effects on the economy, leading to decreased capital formation and hindering true economic progress. Artificially stimulating demand through inflation may seem to spur economic activity, but it is not a sustainable approach for long-term growth. Moreover, due to the current low interest rate policy, the diminishing returns on low-interest rates in the face of increasing risks have led to a reluctance among banks to expand credit. This, in turn, exerts downward pressure on the money supply, despite efforts by the central bank to stimulate inflation.
One way the central bank could counteract this decline is through an aggressive inflationary approach, such as monetizing government spending or distributing checks to citizens. However, these actions ultimately undermine genuine production, savings, and capital investment.
In times of economic downturn, there is often a call for government intervention to prevent further deterioration. However, it is important to recognize that both the central bank and the government rely on resources diverted from the private sector, which is the true generator of wealth. Any interventions by these entities will only distort the production structure and hinder wealth creation.
While some may argue that inflationary policies can create a temporary illusion of prosperity by boosting demand, this does not lead to sustainable economic growth. Without a corresponding increase in stable production and savings, increased demand will only serve to weaken the economy in the long run.
It is essential to understand that economic growth cannot be achieved through inflationary measures that only increase consumption without boosting production. Such actions ultimately hinder savings and impede genuine economic progress.
Please note that the opinions expressed in this article are solely those of the author and do not necessarily reflect the views of The Epoch Times.
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