Syndicate
Balance of the Monetary Supply and Demand
Just like everything in life, balance is something essential. If a government prints too much money, the prices go up and it causes inflation, whereas if they do not print enough money, the prices go down and it causes deflation. All right so after all that is said, what is the correct amount and why does printing too little or too much cause deflation or inflation?
On the whole, the value of money is determined by supply and demand such as:
- The government controls the supply of money and the government can easily print more money when they want.
- The demand of money precedes its utility as a means of payment and the fact that its availability implies not having to recur to trade.
For a given level of monetary supply, supply and demand interacts to determine the value of each unit of money. If the supply of money is scarce, each unit is very valuable, and the fewer amounts of pieces of money there is available, then the less chances there are of avoiding trade. But if the government considerably increases the monetary supply, each unit of money loses its value because it is then easy to obtain enough money to avoid trade.
The prices and the value of money are inversely related so that when the value of money increases, the prices go down, and it works the same way the other way around. To see how this relationship works, suppose that the supply of money is very low and that, as a consequence, its value is very high. Since the value of money is very high, you will be able to buy a lot of things. For example a dollar can buy 10 pounds of coffee, meaning its ten cents per pound. However if there were an abundant amount of money, each unit has a lower value. In this case, a dollar can buy just one pound of coffee. So the higher the supply of money, the higher the prices will be.
The demand of money tends to grow slowly through time; the economies in growth produce more goods and consumers demand more money to buy them. Depending on the government’s reaction to this mayor money demand, there are three possibilities of what could happen:
- If a government increases the money supply in the same proportion in which the demand increases, the prices do not change, in other words, if the supply and demand of money increased in the same proportion, it’s relative value would not change.
- If the government increases the money supply quicker than the demand grows, inflation is caused as this becomes relatively more abundant and each piece of the same has relatively less value. Since each unit of money is less valuable, more money is needed to buy goods, which causes an increase in the products.
- If the government increases the supply of money slower then the demand, it causes deflation because each unit of money is made relatively more valuable. Less money is needed to acquire a good or service.
You might wonder if there is any way of knowing exactly how much inflation can be expected when printing a determined amount of additional money. Well the answer to that has to do with the quantitative theory of money, which affirms that the general level of prices is proportional to the amount of money that is circulated in an economy. Proportional means that everything increases in equal amounts, so the quantitative theory can be expressed like this: If the supply of money is duplicated, the prices are duplicated.
But why would a government want to cause an inflation or deflation of any kind? if you are interested in finding out continue on.