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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The size of an economy is determined by the value of what is produced, not by how much money is in circulation.
TL;DR, you have deflation. More stuff but the same amount of money means that each unit of money now purchases more stuff. Ultimately, money is just the denominator of the economy.
Money isn’t real. It’s all made up. The economy grows when we collectively _imagine_ that it grows.
OP, your question is smarter than the top replies.
The economy basically doesn’t grow unless the money supply increases in the money supply to match it. Every gold standard the USA has implemented has collapsed for the same reason that it doesn’t sustain itself. We’ve had many different gold standards.
Every period of growth during a gold standard came on the backs of huge private debt increases from bank loans, or new sources of gold acquired from mining or from exported goods for gold.
While the real economy (total goods and services, distributed among total population) is separate from money as a phenomenon, and the actual work of growing an economy is the work to make more, new, better, etc, stuff, we know that in a moneyed system a lack of money means people aren’t making the stuff, aren’t inventing the new tech, they’re just hungry and unable to buy tools.
People who don’t know their economic history can try to talk about how we’ve had deflationary growth and the (original) great depression of the 1870s-1890s is a myth, but if you trace bank lending and gold stocks and go into those years, the parts that hold up “the economy grew” was the part where there were money increases, and the parts that get that era called a depression are when money increases didn’t match economic increases.
People will furthermore argue money velocity. But money velocity isn’t known to speed up when money itself gets tightened. Indeed, quite the opposite. Any sustained growth will need an increasing money supply.
**So the shortest answer is “it grows because** (when….) **banks lend new money into existence faster than the loans are repaid, regardless of gold.”**
A longer answer is a caveat “and this is more likely when governments can push interest rates down by acquiring new gold, or when governments are forced to spend new money regardless of gold”
But a longer answer is “financial crisis destroys the gold standard and the government has to fix money through massive spending such as ww1, great depression 1930s edition through ww2, etc, or when the government spends its way out of being able to maintain a gold standard such as the 1950s-60s”
source: actually studied this. Actually-actually.
Economic growth comes from the velocity of money — how fast it changes hands.
You have $100. You might just keep it in your pocket and it doesn’t do anything.
Or you might buy a paid of shoes with your $100. And the shoe store owner takes his wife out for a $100 date night. And the chef spends $100 on a new knife. And the knifemaker spends $100 on swimming classes for his kid. And the swim instructor spends $100 on getting her hair cut. And the salon owner spends $100 on a new sign. And the sign maker spends $100 on…
So $100, changing hands 7 times created $700 in economic activity.
In theory you can have deflation so the price of everything falls and so you don’t need more cash gold to go around.
But your question is right.. not having enough cash gold would be problematic and probably lead to band-aid solutions like bank script or stretching fractional reserve banking to the max. It’s a flaw you get with X backed currency.
If you think about it, prices “should” go down as we become more efficient. Why would a kg of bacon go up in price every year.
But the experts say that the negative development in prices would lead to people stowing away money and have an overall negative effect on the economy. The central banks tend to aim for 2% inflation.
Somone else might be able to elaborate.
-Someone who is not an expert.
Money is a system of transferable debt (may be to some particular institution, as in a corporate bill or a credit company, or just anyone recognising the token, as in a bank note or a coin). There is no particular limit on the amount of debt issued at any one time – it’s always coming and going through multiple channels. There is a lot of effort put into sorting the different grades and keeping the amount roughly consonant with the amount of goods and services available. The gold standard was one of these efforts – but gold only ever covered a fraction of the money supply. It was basically a test – if you doubted the worth of the note you demanded to see the gold backing it. Of course, if everyone demanded gold the system would collapse, but the big players – Bank of England, Bank of France etc, kept the system stable by limiting runs.
The awnser is that the money supply grows. The gold standart was abandoned over 50 Years ago. But if it wasnt it would lead to deflation.
Growth without an increase in the MS is not posible. (under a Capitalist System)
Why would a Businessman invest if his return on investment is lower than just leaving it in his Bank Account.
Thats why most economists agree that 2% inflation is optimal for Economic growth
But the money supply is constanly fluctuating because Private Banks and Central Banks constanly lend out money to each other, consumers and Companies.
What money really is, is a Tool we use to distribute the Wealth created by the Economy.
I describe it like this. Imagine 5 people have 5 dollars each. If they each spend their $5 in a year and make $5 they get $5 worth of stuff but their net worth doesn’t change. Now imagine they spend and make their $5 twice in a year. They each get $10 worth of stuff. There’s still only $25 worth of money in the system. Not make it 4x a year. Everyone gets $20 of stuff and the system is still only $25 net. And so on.
What really matters in a system is how many times each dollar is spent.
This is also why the wealthy are actually more damaging to a system than people realize. The poor have to spend each dollar as it comes in. And as they do the whole system gets richer. The wealthy can hold and hoard those dollars and everyone else makes less.
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