What Is The Optimum Quantity of Money In An Economy?

The correct answer is “any amount will do” as long as the money is divisible.

A short example might help explain this very straight forward fact. Let’s say you and your best friend decide to play Monopoly. As you open the box you discover to your horror that all the money is missing. As it’s impossible to play the game without it, the both of you agree to create money out of pieces of paper in just one denomination, each representing 1 MM (Monopoly Money). How many MMs do you need to create? At minimum, you need enough units to cover all possible purchases and penalties, big and small. Making a potentially longer story shorter, say you need a minimum of 1,000 MMs to play the game effectively. But to make it more fun (bigger numbers are more fun, right?), you decide to create 10,000 MMs. But why not make 100,000 MMs? Or 1,000,000? Assuming it takes no additional effort to make more and that it’s no less practical to play the game with more MMs, the point is that the number of MMs does not matter. Why? Because you can simply adjust the various prices to make any number of MMs sufficient. You can also make do with 10 MMs each, if they could be divided further, e.g. turning 1 MM into smaller denominations so that for example 100 Mini Monopoly Money (MMM) are worth 1 MM.

The lesson of the above example is that an economy can never suffer “a shortage of money”. If the amount of money remains stable, but the number of goods available for purchase increase, the price for each good will simply decline (and the purchasing power of money increase). Conversely, if the amount of money increases, but there are no increase in the number of goods, prices will increase as they are bid up.

What’s the implication for monetary policy? Unless the policy is to keep the amount of money in circulation (the “money supply”) unchanged (that would be a day to celebrate), it renders money supply manipulations useless as a means to increase prosperity. Nor can it increase employment. What monetary policy can do however is to manipulate who wins and who loses. For example, when the money supply increases, whoever receives the new money first wins and people on fixed salaries lose. When the money supply decreases, creditors win as they get paid with money that are worth more than they lent out initially. And, of course, monetary policy has the power to create inflationary booms which inevitably lead to production in the wrong lines of business, capital consumption and the general impoverishment of an economy.

Therefore, any amount of money will do and an economy does not need a central bank and its banks to create ever more money. The amount of money we have currently suffice, as did the amount of money we had 50 and 100 years ago.

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