eli5: How does an economy grow if the money supply doesnt increase in that same year? In gold standard suppose, gold reserves are not increased but economy still manages to grow. How is that possible, how is an economy growing on a stable money supply?
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So what makes this question really interesting is that Adam Smith, father of modern economics, believed that an economy shouldn’t grow over the long term. It might have fluctuations in thr short term, but on average, it would always return to a baseline.
So how did we go from thinking an economy doesn’t grow to continual annual growth seemingly being the norm?
It has to do with how economist measure growth. The word “growth” implies some sort of change over time. So what’s changing over time?
The answer is output, or how much stuff a country produces. You’ve probably heard of Gross Domestic Product, or GDP. This is just the monetary value of all the stuff a country makes.
So let’s say you declared independence and made your house/apartment a micro-nation. In a year, you make 100 chairs valued at $5. Your GDP is $500. If next year, you produce 150 chairs at $5, your GDP is $750 and your annual economic growth is 50%.
So why does an economy grow? Especially when Adam Smith said it wouldn’t. The answer is that Smith was correct – based on all the data he had seen so far. He lived in era when the industrial revolution hadn’t really came into full swing yet.
Technological innovation makes it possible to increase output given the same amount of resources. If your little micro-nation invested on a chair-making machine and you suddenly were able to produce 500 chairs in a year and you continually invest in chair-making machines to increase your chair-making abilities, you’ll see annual economic growth each year.
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