There has has to be enough money, in sensible units, to represent the value of all the goods and services that are traded with it, so as the economy grows, there has to be a proportional increase in the money supply, otherwise your currency will appreciate to unwieldy levels and you’ll suffer from effective deflation.
The key idea here is not that you need enough currency to complete all transactions (since money gets reused many many times), but that people’s desire to hold a currency is a key determinant of its value. If people’s desire to hold a currency increases in real terms (such as during , but the nominal amount of money does not increase then the currency has to appreciate. This can lead to unwieldy currency units as you mention, but it also has bad dynamics. An overall shortage of money will lead to a reduction of economic activity as people try to get more currency (this logic also works in the reverse direction).
Fiat (public or private) currencies have the advantage that they can increase or decrease the amount of their currency in circulation at will using open market operations to match people’s overall desire to hold their currency. Whether this advantage is actually an advantage depends on how good of a job you think central banks do of actually doing this.
Inflation talk like this always makes me antsy. I pretty much agree with what you say above, but a monetary interpretation of inflation, specifically as regards the money supply relative to total economic activity, strikes me as the most sensible way to talk about why we’d experience de facto deflation with an exhausted commodity-backed currency in a growing economy, which was the salient point as far as bitcoin and the Gold Standard are concerned.
I don’t think the desire-to-hold interpretation of currency value is incorrect (in a sense it’s almost tautologically true), but in this case I think it makes sense to view that as a repercussion (an increase in demand for finance with no corresponding increase in real loanable funds, for example), rather than as a driving factor. The money supply is opaque to most agents in an economy, and their desire to hold onto it is based on how much they can get away with sitting on at any given time. If the money supply is small in relation to the number of transactions they have to make, that number must, by necessity, decrease.
Edit: Wait a minute. That last bit doesn’t make any sense at all. If I’m an agent in an economy, my only evidence for the true value of the money supply is how much I can buy with it relative to what I could buy with it in the past. After a period of growth I should be able to purchase a relatively larger amount with the same quantity of currency, so in that sense I guess my desire to retain currency is a direct effect of growth with a fixed money supply without even having to think about the size of the money supply in relation to transactions. They are implicit in whatever background activity is responsible for the growth, however.
Hm. OK. I could be convinced that either angle is useful for addressing the issue. I guess it depends on where you think the action is. The example of number of borrowers in relation to loanable funds is definitely one for the money-supply-to-economic-activity ratio. It’s also possibly best dealt with in terms of interest rates, but it suggests a category of coarse, high-capital exchanges which are susceptible to policy intervention. On the level of individual economic agents, currency-retention is probably the easier idea to work with, but it’s dealing with very fine-grained aggregate processes that are less tractable in terms of interventionist policy.
I don’t understand what you mean. Are you just saying “the way I explained it is a quick way to communicate the sort of problem I have in mind”? Your mention of inflation confuses me because neither of us had mentioned it before.
I didn’t mean to say “the value of money = desire to hold it”, which I think would probably be wrong or ill specified. A price is the rate at which you can trade one good for another good. Money has lots of different prices (2$ per lb apples, $300 per oz gold etc., $50 per hour of massage etc.) since it participates in lots of different markets, whereas most goods only participate in one market (where they can be traded for money). You can talk about a “price level”, but coming up with a precise and useful definition is a little tricky.
I just meant that if for each agent, the marginal utility of money rises (or you add more agents) and the quantity of money does not rise then at equilibrium the price of money will have to rise across the board (deflation). I was saying that your example of economic growth leading to more transactions is a special case and trying to explain that broader framework.
There are many reasons why people’s general desire to hold money might rise or fall, for example if a checking mechanism is introduced then people will need to hold less money to conduct their transactions (reduced desire to hold money) or if there’s a global financial crisis, people might say “holy shit, I can’t trust any of these assets, I’d best just hold money” then people’s general desire to hold money would rise.
Sorry...you might want to see my edit, which I started before reading this response, and which basically (although less concisely) repeats your explanation about marginal utility of money rising for each agent.
I have totally confused the issue, and you are quite right.
That makes more sense to me. Have you heard of Monetary Disequilibrium theory? It’s the most reductionist approach to monetary economics, and what I was describing more or less.
Not by name, but it seems highly compatible with many other accounts of macroeconomic fluctuation.
As you may have gathered, macro is not my strongest suit. I mostly hopped on board an econ syllabus for other reasons, and now find myself with a whole bunch of useful and explanatory macroeconomic concepts that most other people have never heard of.
A nit pick:
The key idea here is not that you need enough currency to complete all transactions (since money gets reused many many times), but that people’s desire to hold a currency is a key determinant of its value. If people’s desire to hold a currency increases in real terms (such as during , but the nominal amount of money does not increase then the currency has to appreciate. This can lead to unwieldy currency units as you mention, but it also has bad dynamics. An overall shortage of money will lead to a reduction of economic activity as people try to get more currency (this logic also works in the reverse direction).
Fiat (public or private) currencies have the advantage that they can increase or decrease the amount of their currency in circulation at will using open market operations to match people’s overall desire to hold their currency. Whether this advantage is actually an advantage depends on how good of a job you think central banks do of actually doing this.
Inflation talk like this always makes me antsy. I pretty much agree with what you say above, but a monetary interpretation of inflation, specifically as regards the money supply relative to total economic activity, strikes me as the most sensible way to talk about why we’d experience de facto deflation with an exhausted commodity-backed currency in a growing economy, which was the salient point as far as bitcoin and the Gold Standard are concerned.
I don’t think the desire-to-hold interpretation of currency value is incorrect (in a sense it’s almost tautologically true), but in this case I think it makes sense to view that as a repercussion (an increase in demand for finance with no corresponding increase in real loanable funds, for example), rather than as a driving factor. The money supply is opaque to most agents in an economy, and their desire to hold onto it is based on how much they can get away with sitting on at any given time. If the money supply is small in relation to the number of transactions they have to make, that number must, by necessity, decrease.
Edit: Wait a minute. That last bit doesn’t make any sense at all. If I’m an agent in an economy, my only evidence for the true value of the money supply is how much I can buy with it relative to what I could buy with it in the past. After a period of growth I should be able to purchase a relatively larger amount with the same quantity of currency, so in that sense I guess my desire to retain currency is a direct effect of growth with a fixed money supply without even having to think about the size of the money supply in relation to transactions. They are implicit in whatever background activity is responsible for the growth, however.
Hm. OK. I could be convinced that either angle is useful for addressing the issue. I guess it depends on where you think the action is. The example of number of borrowers in relation to loanable funds is definitely one for the money-supply-to-economic-activity ratio. It’s also possibly best dealt with in terms of interest rates, but it suggests a category of coarse, high-capital exchanges which are susceptible to policy intervention. On the level of individual economic agents, currency-retention is probably the easier idea to work with, but it’s dealing with very fine-grained aggregate processes that are less tractable in terms of interventionist policy.
I don’t understand what you mean. Are you just saying “the way I explained it is a quick way to communicate the sort of problem I have in mind”? Your mention of inflation confuses me because neither of us had mentioned it before.
I didn’t mean to say “the value of money = desire to hold it”, which I think would probably be wrong or ill specified. A price is the rate at which you can trade one good for another good. Money has lots of different prices (2$ per lb apples, $300 per oz gold etc., $50 per hour of massage etc.) since it participates in lots of different markets, whereas most goods only participate in one market (where they can be traded for money). You can talk about a “price level”, but coming up with a precise and useful definition is a little tricky.
I just meant that if for each agent, the marginal utility of money rises (or you add more agents) and the quantity of money does not rise then at equilibrium the price of money will have to rise across the board (deflation). I was saying that your example of economic growth leading to more transactions is a special case and trying to explain that broader framework.
There are many reasons why people’s general desire to hold money might rise or fall, for example if a checking mechanism is introduced then people will need to hold less money to conduct their transactions (reduced desire to hold money) or if there’s a global financial crisis, people might say “holy shit, I can’t trust any of these assets, I’d best just hold money” then people’s general desire to hold money would rise.
Are we communicating better?
Also I categorised this as “inflation talk”, because it was wheeling out a few of the concepts behind the question “what are the causes of inflation?”
I think there’s something about macro that makes me communicate badly.
Sorry...you might want to see my edit, which I started before reading this response, and which basically (although less concisely) repeats your explanation about marginal utility of money rising for each agent.
I have totally confused the issue, and you are quite right.
That makes more sense to me. Have you heard of Monetary Disequilibrium theory? It’s the most reductionist approach to monetary economics, and what I was describing more or less.
Not by name, but it seems highly compatible with many other accounts of macroeconomic fluctuation.
As you may have gathered, macro is not my strongest suit. I mostly hopped on board an econ syllabus for other reasons, and now find myself with a whole bunch of useful and explanatory macroeconomic concepts that most other people have never heard of.