Commercial banks (the places where you and I bank) and the central bank (the Federal Reserve, in the US) both participate as needed in maintaining the money supply. Some people take this to mean that banks decide how much money there is in the country, which could be considered either true or false, depending on what one means by “money”. I’ll put it plainly: banks aren’t deciding how much wealth there is in the country, because the workforce does that by producing output. Banks are deciding how many dollars there are in the country, the units by which we measure that wealth.
(more…)Tag: inflation
Inflation and Deflation
Let’s discuss the true nature of the relationship between money supply and inflation/deflation. Imagine an island inhabited by a handful of people. They all work at the coconut tree farm, tending and harvesting coconuts and putting them in the barn for later purchase. For each day’s work, they get a seashell which they take home and put in their sock drawer. This is their island’s currency, which they will later use to buy coconuts.
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