It depends on if we want our output of valuable stuff (not just consumer products, but homes, health care, education and research) to grow or not. If we want them to grow, we need a growing money supply.
If not, you won't spend your money on any of those things, and if you don't spend your money on it, the demand goes down and less of the stuff is produced.
The reason you won't spend your money today is because you'll get more tomorrow, so why not buy it tomorrow? And why spend your money tomorrow when you'll get more stuff the day after tomorrow?
And if most people aren't spending their money, you don't get any money either, because you only get money by someone else wanting what you produce (or wanting what your investment produces). Then you'll spend even less of your money, because now that you're strapped for cash, you really need to wait until the prices drop to maximize your purchase power.
It's the main reason we have near zero interest rates across the West years after 2008; that crisis was deep and we need to drive up inflation to kick start the economy for real and make the growth more equal.
This is a strong argument and I feel like it makes sense.
Doesn't it rely on the premise that "we" (as a society) are deciding what currency all of us will use? I think what you're saying is totally true, but as a single rational person, I'd rather store my savings in something that is not (by design) decreasing in value.
People could always theoretically do this with gold, but it's not quite the same since gold has its own risks (like it being lost or stolen), ongoing costs (to protect it), and is trickier to trade.
Bitcoin is still in its early phases and another cryptocurrency may surpass it at some point, but if we don't already, it's likely people will have increasingly easy access to currency that is algorithmically constrained (like Bitcoin). Won't people rationally flock to such currencies, and if that's the case, won't it be difficult to encourage spending / investment using a minorly inflationary currency?
> but as a single rational person, I'd rather store my savings in something that is not (by design) decreasing in value.
That's one of the reasons currency decreases in value, it's a deliberate effort to get people to use just about anything else as a store of value.
> Won't people rationally flock to such currencies
Supply constraints combined with utility to drive demand (whether a supply constrained “currency” has the latter is another question) makes for a good store of value—investment—but that's orthogonal to utility as a currency.
That last point is really key I think - If people flock to a currency as a means of growing their holdings value then it's not really a currency, it's an investment vehicle.
That argument has been levelled and Bitcoin, and I personally agree with it. It explains the adoption boom up to this point, and off the back of it it's possible to fairly confidently predict a bust when returns fail to materialize. Right now returns are based on adoption coupled with increasingly constrained supply.
It is both a currency and a means of investment, all currencies are, even inflationary fiat currencies, the people who get in first when interest rates are high can earn a lot of interest before the currency is eventually devalued by the controllers.
In theory, when bitcoin reaches a saturation point of adoption, the value of bitcoin won't increase anymore (it can't if there is no more demand). At this stage deflation would technically have stopped and the currency is matured.
This should lead to a much more stable economy than we have now, where people aren't encouraged through the use of cheap credit to make emotional purchases for things they don't need, sure the economy might not "grow" at the same rate but the growth would be a more precise representation of what people truly needed (instead of just being a big party). Maybe people would even lead more stable responsible lives.
Sure, and I almost certainly would. But isn't that side-stepping the issue?
I could invest with a deflationary currency. I might not have 100% of it invested at every moment. When I do, the company could hold onto that for a while until they're able to make use of it. It benefits both of us (individually) for that money to not be decreasing in value, even if it works against us (as a society) in that we have decreased incentive to spend.
The key question is that if normal rational people would choose a deflationary currency if given a choice, and that choice is becoming more and more realistic, at what point does the current strategy of "assume everyone uses the nation's main currency and do what's best for the whole economy" not work any more?
> at what point does the current strategy of "assume everyone uses the nation's main currency and do what's best for the whole economy" not work any more?
When the government stops using it as the basis for taxation, damages in civil cases irrespective of the specific nature of the assets at issue, and criminal fines.
Because as long as those (especially the first two) are true, essentially everyone will use the natiobal currency substantially, both directly and indirectly, regardless of what other assets and currencies they use, and normal monetary policy measures will affect the broader economy in the normal manner unless the auxiliary currencies are actively managed to counteract national monetary policy.
There are already companies that allow you to pay federal taxes with Bitcoin (by converting them to USD for you). There are already debit / credit cards that allow you to have your account funds in Bitcoin, but convert to USD for a merchant when you use them.
I guess to me it doesn't seem fundamentally impossible that those things could be based in a national / fiat currency that is not the same currency a large number (or even majority) of people use.
> There are already companies that allow you to pay federal taxes with Bitcoin (by converting them to USD for you)
That's immaterial, in the same way that you can sell non-currency assets to get dollars to pay federal taxes is.
As long as the taxes are denominated and collected exclusively in dollars (and as long as that's the norm for civil damages, as well), the supply of dollars will affect the economy in the usual way, whether or not for most transactions people directly use things that are not US dollars.
This isn’t quite correct. Technically I’d say it’s highly incomplete, and that incompleteness makes it wrong.
For instance, a side effect is that only high productive investments will be made. That leads to high return on investment. Which leads to higher profitability. (Look up ROIC if you want a quick overview of the effect - it’s very well documented).
What’s this leads to is a society which has a highly improving productivity, and therefore a highly improving quality of life.
I’m not sure why some economists leave this effect out. It’s a very significant effect, and leads to a different set of outcomes when you include it in a model.
Side note - using ROIC is a great filter for ranking companies to invest in. Over the longer term, companies with higher ROIC tend to significantly beat their competitors.
> And why spend your money tomorrow when you'll get more stuff the day after tomorrow?
Right, we'll die of starvation because our money will be worth more in the future. Instead of paying rent we'll all sleep in cardboard boxes. Then the economy will grind to a halt and global warming will cease to be a threat. Thus resulting in the onset of another ice age. The reason you don't want another ice age is, it'll destabilize the snow-shoe equities market. It's all pretty self-explanatory. (This is how I imagine your typical economist reasons).
A more specific question might lead to a better discussion:
If the economy-wide goal[0] is increasing wealth[1], then why are increasing prices better than flat or decreasing prices[2]?
[0] There is general consensus that stable economic growth is our macroeconomic goal, generally defined as increasing output per person, or GDP.
[1] Generally in economics this is taken to mean real purchasing power.
[2] An increasing money supply is a side effect of the real goal of central banks: small amounts of inflation. If a population were shrinking, or if output was contracting, it might well mean that the money supply could remain flat or decrease and there might still be inflation. But as the population grows, the money supply must increase not just to keep prices flat but to encourage slight inflation.
Keynes writes brilliantly on this topic in "Essays on Persuasion," and many of the points are addressed here in the comments. But it can generally be distilled into three main points:
A low level of inflation
1) compels business activity because businesspeople can sell things at a higher price than they paid for all of the inputs;
2) compels consumer spending because today is the most valuable your cash will ever be; and
3) compels lending because there is a cost to simply doing nothing with cash.
Without those incentives, there would be a severe pull-back in lending, spending, and business and job creation, which are the same deflationary forces fought in the 2008 financial crash.
Let's say you have a successful manufacturing business, and you need to buy a new machine to produce and sell more of your stuff. The machine costs 1M and will last 10 years. You go to a rich friend of yours and ask for 1M DeflationaryDollars to buy that machine; your friend accepts to lend you that money for 10 years, at a 10% annual interest. You agree to pay the interest every year, and to give back the principal at the end of the 10 years.
The first year, you buy the machine, put it to good use, and sell more of your stuff for an additional gross profit of 200K - a GREAT return for a 1M machine. After paying 100K interest to your friend, you're left with a good 100K in pre-tax profit, which isn't bad at all!
The second year, DeflationaryDollars deflated by 10%. You're lucky, because all your employees gladly accepted a 10% salary cut, you slashed your prices by 10%, and you still make 180K in gross profits from your machine. But you still need to give your friend 100K, so your pre-tax profit is only 80K.
Third year, another 10% deflation. Gross profits are 162K, you're left with 62K after paying interests.
Fourth year: gross 145.8K, 45K after interests.
...
Eighth year: gross 95.6K, but you need to pay 100K in interests. You better have saved your profits from the previous years, and not paid any taxes on them, otherwise you're already in trouble.
...
Tenth year: gross 77.5K, and you need to give 1.1M to your friend. But the total gross profit you made before taxes was 1.3M, so, even with a very low tax rate, you're broke, because your machine is worth nothing by now. Next time, instead of investing to expand your business in a deflationary environment, you should think better and just spend as little as possible, save and hoard your DeflationaryDollars under your mattress, like most other people are doing.
As in, creating software to produce a database which you call hmm maybe a "Softcoin" and you would limit the supply by typing an arbitrary number in the source code, say 21,000,000?
After you run the software to generate the coins, you can sell them to other people and tell them the coins are rare. Maybe you can leave a few coins to be generated by other people too, that way they you can let them feel like they're part of it.
Ahhhh, I see now. Well, yes, of course I was thinking about those Softcoin, but preferred using values in "dollars" that would make some sense to the reader ;)
The current belief is a monetarist one: that more money in the economy, up to a certain degree, can lead to greater economic growth.
Hence, why low amount of inflation is considered a good thing, and sometimes used to measure the health of our economy.
This comes from a quantity theory of money -- MV = PQ, where M is the total amount of money in circulation, V is the velocity of money (or the amount of times it exchanges hand in a given year), and PQ is equal to GDP [1].
To understand this belief, we should consider 3 scenarios: deflation, low inflation, and high inflation.
In a deflationary economy, where 1 dollar today is worth more than 1 dollar tomorrow, people are incentivized to save. What follows is a decrease in M and or V, which has a detrimental multiplier effect on PQ. Under these circumstances, owning a business would be very hard as interest rates would be incredibly high.
Let's consider the opposite event -- high inflation. In a highly-inflation economy, where 1 dollar today is worth less than 1 dollar tomorrow, people would be incentivized to spend. This may initially sound like a good idea, with M and V increasing, and interest rates extremely low; but in a global economy, greater foreign demand for goods would drive up local prices, resulting in people unable to buy the goods and services they want. There's that other thing where wages are sticky, or not as reflexive to economic changes as prices are.
The happy medium is a low-inflation economy, where people are incentivized to spend and banks willing to loan, and saving money a low-risk activity.
Some things (like labor) simply do not react well to a decrease in price. And if your money supply isn't increasing, those will see some years of price increases and others of price decreases.
This is an argument against inflation. The fact that an invisible hand can manipulate the value of wages further weakens labors bargaining power — a power which has been nothing but eroded over the last 50years. Sorry, I feel employers should at least be honest and upfront with their employees when they’re cutting wages.
It's not really acting upon bargaining power. If you look at almost every instance of nominal rigidity around, you will see it is caused by some kind of government intervention. On labor, it is mostly illegal or really hard to reduce salaries, even on deflation. That would force companies into firing people instead of just correcting their salaries.
I am not convinced it is a good reason for inflation. It is the reason for inflation. It does exist. It does cause a lot of problems (as in bankrupting even rich countries) when inflation is gone.
Yet I do think it is self inflicted in that a society can organize in a way that where it doesn't exist. I also have no idea it this way would be better or worse than our current ways.
I think it has less to do with merely growing the money supply, and more to do with preventing and quickly recovering from crashes.
The Great Depression was exacerbated and prolonged by us being on the gold standard and thus not being able to use monetary stimulus. Also with a gold standard, there's a limit to how much fiscal stimulus a government can conduct as well because every dollar has to be convertible to gold.
Essentially, fixed money supply = less control. On the surface this might seem like a good thing, and if money is in the hands of a corrupt oligarchy I'd prefer the fixed money supply. But most people don't realize that only 3% of the money supply is printed by the government (the rest is created by private banks), and economic bubbles/crashes and inflation/deflation aren't restricted to fiat currencies.
Section "Money creation in reality" [1]. States that 97% of money in circulation are from bank deposits, the majority of which are themselves created by commercial banks (though it doesn't explicitly state that the rest comes from governments).
If you're willing to ask the question and listen to the answer then you're not in the set of idiots.
I'll go for the short answer rather than the wall-of-text exhaustive answer. Deflationary currency leads to stagnation. People buy less because holding money under the mattress is incentivized. Its nearly impossible to run a business in an economy where people only buy essentials and never loan money out as startup capital.
Look at the history of economic panics in the US back when the gold standard was a thing.
I'm into bitcoin for reasons other than the 21 million limit.
Deflationary money (a fixed money supply) encourages people to hold money and not spend because the same money will buy more goods and services tomorrow. This leads to a decrease in economic activity.
[update: I see this argument is raised over and over in other parts of this discussion, I didn't add much]
Because if you're saving your money, you're not doing anything constructive at all. I sure as hell don't want people saving their money, I want people to invest their money.
Wether it's a savings account, a 401k or a revolutionary business idea everything is better for society than your mattress. And people won't invest in anything today when they can invest more tomorrow, but then they'll wait until after tomorrow, or the day after that, or not at all because they reached that time when they eventually have to spend (which would mean they're broke, which is bad).
This isn't true, if you are saving it you are reducing supply and driving the price up. This gives economic opportunity to other savers who at some point may try and build or sell something that has a greater rate of return than the deflation rate.
No, you're reducing the supply of the currency, you're not reducing the supply of stuff the currency can buy. If the amount of stuff drops but the currency stays the same, the price increases but if the amount of stuff the currency can buy increases but the currency stays the same (as in, the number of Bitcoins have capped) the price drops.
If other people build something or sell something they increase the supply of stuff which makes the prices drop if the currency stays the same. In other words, they're less incentivized to build or sell something (since selling and building has costs) than just keeping the money themselves in their mattress if the amount of currency is fixed.
Saving is investment, as long as you mean it in terms of a bank account & fractional reserve banking, in which case banks just re-lend that money to someone else as for example a loan or mortgage.
The only reason saving it in a bank account is an investment is because more people are borrowing than saving, thus the bank makes money and gives you a share of the profits (that's your saving's interest). If everybody's saving, nobody gets any return on it and all that money does absolutely nothing for society at all.
I don’t buy your argument. People will still invest because investment generates a return on their money. Additionally, if the savings rate becomes too high the government has the ability to tax and reinvest that revenue as appropriate.
Inflation is a hidden tax that impacts the poor and middle classes the most. Worse, wealthy people have the means to escape inflation. Today the worlds weathiest simply buy land and property. Is that the sort of “investment” you’re cheering for as a positive result of inflation?
The problem is that with a deflationary currency, the only risk you run into is if the amount of stuff drops because that's the only way this global currency would drop in value; the perceived amount of stuff it could buy drops. Every other investment has much greater risks, so why would people chose them? And what's saying the return would be higher for that stuff anyway when everyone's saving rather than spending, why would anyone spend their money on the output of your investment? Not saying you're wrong, I'm saying there's a very high likelihood it won't result in investments, far higher than I would like.
And it's good that you brought up land and property because that's exactly what I don't want people to invest in (unless they actually want to use it for production, like renting it out to people or companies) but housing is something a lot of people do invest in for retirement, especially in my country. I would much rather people invested it in their 401k, a mutual fund, their business idea, bonds or whatever would enable production. Inflation is a tax on people who have money in their mattresses, if you invest money rather than save it you will beat inflation over your life. That's what I want people to be incentivized to do, not to pile them up or freeze them in status symbols like homes.
And inflation can actually help the poor, it makes it much easier for them to pay off their debts as the principal decreases in value. It's the main reason poor farmers fought for bimetalism in Gilded Age America because rich bankers were making a killing on low inflation.
I don't think it leads to a decrease in economic activity, just discourages an increase.
Why doesn't it lead to a decrease? Well, as soon as the economic output decreases (but the money supply didn't change!), then each dollar is worth less, so the incentive (to not spend because it will be worth more tomorrow) disappears, so the spending starts back up...
We don't just spend money on consumer products and food. We need more health services, research, water, education, affordable housing and much more. None of this is free, all of it is dependent on people making money producing this stuff. No demand, no stuff.
If everyone kept all their cash under their mattresses, what makes you think your employer would be able to pay your salary? Where would your employer get the cash to pay you?
A healthy economy requires money to flow through it at a healthy, manageable rate.
Because economic output is growing. If the money supply grows to match, then each dollar has a stable value. If the money supply doesn't grow, then each dollar becomes worth a fixed fraction of the economy, and therefore the value of the dollar grows as the economy grows. (It's essentially the same as saying, if the amount of liquid increases, we want the number of liters to also increase, so that a liter can represent a fixed amount of liquid.)
Why does that matter? Well, let's say you own money on your house. And let's say that each of those dollars is worth more money, year after year, for a thirty year mortgage. That's going to become a problem, a big enough problem to crush you.
My very rudimentary understanding is that if the amount of money flowing around the system is static (or reducing), then the money itself will increase in value over time (scarcity + demand). In that situation, it's (individually) most rational to hold on to your money and never spend it - it'll be worth more the longer you hold! This then results in the flow of money in the system trending towards zero. Which means everything locks up.
So tl;dr static money supply directly leads to the economy grinding to a halt.
I'm not OP and won't try to give a lengthy explanation, but one key element is that by controlling the amount of money available (by adding or removing some depending on the financial environment) is how the government avoids the 'boom and bust' economy of the gold standard.
There is a misconception that governments only 'print money' and push it out, creating inflation. But this isn't true. Governments also take money out of circulation to prevent the economy from overheating.
There is an implication here that there is only one way to address the boom and bust cycle. Furthermore why is the root cause of boom and bust not addressed? Currency manipulation seems like a bandaid for a gunshot wound.
