Commentary
Is it possible for an increase in the demand for money to offset the effects of an increase in the money supply? For example, if the supply of apples increases by ten while the demand for ten apples also increases, the additional supply would be completely consumed. In other words, once individuals have satisfied their demand for ten apples, there would be no surplus apples left.
Following this reasoning, it seems that an increase in the money supply could be counteracted by a corresponding increase in the demand for money. Therefore, to maintain economic stability, it is crucial that any rise in the demand for money is met with a proportional increase in the supply. Failure to match the increase in money demand with an increase in supply could lead to deflation.
According to traditional monetary policy, to prevent economic shocks caused by imbalances between money supply and demand, the central bank must ensure that supply and demand are in sync. When there is an increase in the demand for money, the Fed may need to increase the money supply through inflation to stabilize the economy.
Some experts argue that the lack of a mechanism to coordinate money demand and supply is a major flaw of the gold standard, leading to instability. It is believed that the supply of gold does not grow quickly enough to meet the increasing demand for money in growing economies.
“The basic problem is that the supply of gold is not related to the quantity of goods and services being produced. As a result, prices decline, leading to reduced incentive for production and stifling economic growth,” as reported by Business Insider.
“Allowing money to become scarce does the greatest harm to those who have the least. In the past, the relative inflexibility of the monetary system contributed to the chronic lack of growth in many of the world’s less developed countries. Since the 1970s, we have had one of the most flexible monetary systems the world has known, and many of these countries have flourished. With a flexible monetary system, more money can be created to accommodate more growth.”
The Meaning of Demand for Money
Demand for money is essentially a demand for the purchasing power that money provides. Money, as a medium of exchange, facilitates transactions between producers and consumers, making goods and services more marketable in the economy.
Unlike other goods, an increase in the demand for money does not imply hoarding money but rather a desire to use it for future exchanges. Therefore, an increase in the demand for money does not necessarily absorb an equivalent increase in the money supply, as seen in the case of goods like apples.
An increase in the money supply to meet a rise in money demand may lead to negative consequences such as inflation and economic instability. This artificial increase in the money supply could trigger a boom-bust cycle and hinder economic progress.
Individuals Demand Purchasing Power, Not Money Itself
Individuals do not desire a greater amount of money in their possession, but rather a greater purchasing power over goods. In accordance with Mises, “The services money provides are dependent on its purchasing power. Nobody aims to hold a specific number of pieces of money or a certain weight of money; rather, they seek to maintain a cash holding of a specific amount of purchasing power.”
Similar to other commodities, the price of money is determined by the laws of supply and demand. Therefore, if the quantity of money decreases, its purchasing power will increase, and vice versa. In a free market setting, there is no concept of an excessive or insufficient amount of money. As long as the market is allowed to function without interference, no shortages or surpluses of money will arise. According to Mises, “Each individual and all individuals together always enjoy fully the advantages which they can derive from indirect exchange and the use of money, no matter whether the total quantity of money is great, or small.”
In an unhampered market economy free from central bank intervention, there is no need to worry about the “optimal” growth rate of the money supply. Any quantity of money will suffice to fulfill its role as a medium of exchange.
If the Federal Reserve were to respond to an increased demand for money by inflating the money supply, this action should be viewed as an artificial increase in the money supply, leading to economic cycles and impoverishment. In a free market environment without central bank interference, the market-selected quantity of money will naturally correspond to the correct amount, eliminating the need for monitoring and control.
The opinions expressed in this article are solely those of the author and may not necessarily align with The Epoch Times’ views.
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