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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It the velocity of money. If I pay someone to mow my lawn, and he pays a farmer at the farmers’ market for some food, and the farmer pays a farm hand, and the farm hand then pays me to adjust his back, then we’re all doing work and helping each other and the same stack of money is getting spent many times over. The issue really isn’t the amount of money that exists, it’s how often the money gets spent, because each time it does that represents someone doing some work in return for it. Building something, repairing something, performing a service, doing work.
The flip side, of course, is that the money’s velocity can also become very low. Suppose the farmer doesn’t actually OWN his farm. A rich guy owns it, having inherited it from his father. The farmer is just renting it. And the rich landlord, obviously, says “You’re not allowed to farm that land unless you pay me rent every month.” So the farmer gives the money to the rich landlord.
Well, the landlord was already rich. He’s been rich all along. So getting that particular stack of money doesn’t enable him to go spend money that he wouldn’t have already spent- he doesn’t need that stack of money to afford anything. So instead of spending it, he puts it in the bank or under his mattress or something.
Now, the money’s velocity is “slow.” It’s not getting passed on to another person to get them to do work. It’s just sitting still. The economy is no longer growing.
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