How does the economy “grow”? Where does the new money comes from?
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People add value through their labor.
I can go out and find a tree branch on the ground, and carve it into a baseball bat, and sell you the baseball bat for $40. I just created $40 of value with my skills and labor.
A bigger economy doesn’t mean more money exists.
The economy is a movement of money and goods. A bigger economy means people make more and spend more, and also produce more.
It all comes down to production really. More labor, more efficient means of production, and you have a bigger economy.
When a government of a country with a sovereign currency spends more than it taxes (ie, has a deficit), the amount of money available increases.
It’s about the flow of money. Who’s spending it, who’s receiving it, and where it goes next. The more people it flows between, the healthier the economy is. The less people it flows to, the bigger the gap between the rich and the poor, the more screwed people become.
Because money is simply a medium, not actual wealth.
It represents *time.* I am willing to give 1 hour of my time, for your widget. This is reprsented by X monies.
Now, one way this can “grow” is how our time is spent.
Lets take two products, a bowl and a hammer. Both things I need. It takes me 1 hour to make a bowl, and 2 hours to make a hammer. So after 3 hours I have everything I need.
You, however, are able to make a bowl in 2 hours and a hammer in 1 hour. The opposite of me. Either due to your skill, or location and access to resources, or whatever.
In 3 hours you have everything you need.
Working alone we need 6 hours of time to make everything we both need to get along.
But we talk to eachother.. and come to a deal. I’ll work for 2 hours only, and so will you. But we’ll both have everything we need. I’ll make 2 bowls (1 per hour), you’ll make 2 hammers (1 per hour) and were’ done.
So now it only takes 4 hours for us to get everything we need. Our economy has “grown”. We have 2 extra hours of free time now.
By specializing my hour is now worth more, able to do more. I can’t do this alone, as I have to coordinate with others, but that’s how it works.
Lets throw money into the mix:
Lets say 1hr work = $1
Alone I spend $3. $1 for the bowl, $2 for the hammer.
Working with you, My $1, can actually buy a hammer.. leaving me with $1 extra that I can spend on something else entirely. I could trade that $1 for another bowl, or go to a third party and get an entirely different item.
The purchasing power of my 1 hour of labor has increased, due to trade.
money needs to have a value (products or services) to back it, otherwise it has no value (and its value will shrink).
the amount of money circulating wont matter much, as the money needed is a fraction of the products/services offered, since you dont use/buy them all at the same time.
“New” money comes from borrowing, and is created everyday. When the loans are paid off, the money is destroyed. As an economy grows, more people borrow which creates more money. Money is in essence debt, and debt is money. Fiat currencies like the US Dollar and the Euro are “elastic”, in that they expand (inflate) and contract (deflate) with the economies they are used within.
The amount of money in the economy is constantly changing.
I find it easiest to understand with a quick history lesson.
Going back to the late 1800s. America (and most of the rest of the world) was on a gold standard with a private fractional reserve banking system.
This first means that the dollar was defined as a set amount of gold, e.g 1 dollar is .25 oz of gold. Not saying that the gold was worth a dollar. THE GOLD WAS THE DOLLAR. So how ever much gold was in the economy was, by definition, the amount of money in the system.
But this process was made more complicated by the fractional reserve banking system. Banks stored deposits of gold and released their own bank notes. This was what paper money was. A 1 dollar bank note was worth a dollar of gold.
But there wasn’t a one-to-one relationship between the gold and the bank notes. A bank could lend out more dollars in notes than it actually had in gold. Typically it only had to have .20 in reserve. That means it could lend $5 in notes for every $1 in reserve. Or it didn’t have to lend any at all.
This brings up the first philosophical question. Which was the real money? The gold was legally defined as the dollar, but the bank notes were what people used. The amount of gold in the economy was roughly a constant, but the amount of notes could be anywhere between 0 and 5x the gold.
For practical purposes it’s the note. It was possible for a gold minor to bring in some gold and get bank notes. The vast majority of bank notes entered circulation through borrowing. People/business/government borrowed notes into circulation. The amount of notes in circulation could be nothing or could be multiples of the gold dollars. The amount was constantly changing.
….Skip a bunch of history…..
The federal reserve was established.
….Skip a bunch of history….
We went off the gold standard.
Today instead of bank reserves being gold, banks get reserves buy borrowing them from the central bank. Banks don’t print there own notes; instead everybody uses the federal reserve bank notes (dollars). As others have mentioned at the base of this is the national debt.
This brings the next philosophical question. Is money the national debt, the bank notes the Fed has released, the reserves the Fed has loaned to banks, or is it the numbers in our bank accounts.
Again in practice it is the numbers in our bank accounts, and like old times bank notes they are created through the lending process. So the total amount of money in circulation is equal to the amount borrowed from banks.
The “growth in the economy” is measured by a growth in real GDP. GDP is the total value of all goods and services produced in a country. Real GDP is GDP but adjusted for inflation. We use real GDP to evaluate whether the economy is actually growing or if it’s just too much money chasing the same number of goods.
Basically, an increase in real GDP means more stuff and more valuable stuff is being made.
A growing economy is one of three macroeconomic goals. These are: Unemployment at its natural rate, strong economic growth (increase in real GDP), small and steady inflation.
A lot of answers about how basic business and money exchange happens, but nobody here seems to understand the monatary system, and money creation.
It used to be different, back when money was actually backed by gold and silver, but I won’t go into that, and instead focus on the modern fiat money system we have.
So basically everything these other people said about economic growth being about time and effort, is true. Extracting resources and creating new things to create value. But the way new money comes into play is a complex system between commercial banks and central banks creating loans and credit.
We have what is called fractional reserve banking. Simply put, what it means is that banks can loan out more money than exists within their reserves. So. Bank hold $1000, and businesses or people trying to buy a house come and collectively borrow $2000 from the bank. The money supply grows and the loan is used to create all that value from working like others have described. As the loans are paid back, that frees up space to create new loans and further expand the money supply, and so on. This is the gradual growth of inflation that goes on, which is different than the rapid inflation we are seeing today.(I won’t go into that). All of this is overseen and squared away with the federal reserve or other central banks.
So what happens if the loans are not paid back? Well you get defaults and bankruptcies, and the money supply shrinks as the money essentially evaporates. The bank has $1,000 and loans out $2000. And maybe $1,200 of it defaults, leaving the bank now with $800 left. This is called deflation, and rarely happens. The times that this happened were in 2008 financial crisis, and other major recessions or depression.
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