Printing Money at a “Constant” or “Stable” Rate Won’t Prevent Boom-Bust Cycles
According to Milton Friedman, the key cause of the business cycles is the fluctuations in the growth rate of money supply. Friedman held that what is required for the elimination of these cycles is for central bank policymakers to aim at a fixed growth rate of money supply:
My choice at the moment would be a legislated rule instructing the monetary authority to achieve a specified rate of growth in the stock of money. For this purpose, I would define the stock of money as including currency outside commercial banks plus all deposits of commercial banks. I would specify that the Reserve System should see to it that the total stock of money so defined rises month by month, and indeed, so far as possible, day by day, at an annual rate of X per cent, where X is some number between 3 and 5. The precise definition of money adopted and the precise rate of growth chosen make far less difference than the definite choice of a particular definition and a particular rate of growth.1
Could, however, the implementation of the constant money supply growth rule eliminate economic fluctuations?
Honest Money versus Money out of “Thin Air”
Originally, paper money was not regarded as money but merely as a representation of gold. Various paper money receipts represented claims on gold stored with the banks. The holders of paper receipts could convert them into gold whenever they deemed necessary. Because people found it more convenient to use paper receipts to exchange for goods and services, these receipts came to be regarded as money.
In fulfilling the role of the medium of exchange, money enables something to be exchanged for it and this in turn enables the received money to be exchanged for something else. That is, something is exchanged for something else by means of money.
For instance, a potato farmer exchanges ten potatoes for the one ounce of gold. The received money, i.e., the ounce of gold, is employed to pay a shoemaker for a pair of shoes. What we have here is an exchange of ten potatoes for a pair of shoes with the help of money, in this case the ounce of gold. This is an exchange of something for something, or an exchange of the produce of one producer for the produce of another producer with the help of money.
Now, as long as the receipts for gold that are accepted as genuine money are backed by gold there is going to be an honest exchange, i.e., something for something, or wealth for wealth.
In contrast, employing receipts that are not backed by gold in an exchange sets in motion an exchange of nothing for something. The unbacked gold receipts do not have any backup of proper money, which is gold. By means of the unbacked gold receipts, goods are diverted from wealth generators to the holders of the unbacked receipts. This weakens wealth generators and in turn weakens the process of wealth formation.
To clarify this point further, consider counterfeit money that was generated by a forger. The forged money looks exactly like the genuine money. Also, note that honest money is obtained by selling some useful goods for it: the potato farmer has obtained one ounce of gold by selling ten potatoes for it. In contrast, no goods were ex
Article from Mises Wire