Creating More Money Won't Revive The Economy

Hence, contrary to the popular way of thinking setting in motion an unbacked-by-production consumption by means of monetary pumping will only stifle and not promote economic growth.

This is because unbacked consumption will weaken the flow of real savings and thus weaken the source that funds real economic growth. If it had been otherwise then poverty in the world would have been eliminated a long time ago. After all everybody knows how to demand and to consume.

The only reason why in the past loose monetary policies seemed to grow the economy is because the pace of real savings generation was strong enough to absorb increases in unbacked consumption.

Once, however, the pace of unbacked consumption reaches a stage where the flow of real savings weakens the economy falls into a severe recession.

Any attempt by the central bank then to pull the economy out of the slump by means of more pumping makes things much worse for it only further strengthens unbacked or non-productive consumption, thereby destroying whatever is left of real savings.

The collapse in the sources of real economic growth exposes commercial banks’ fractional reserve lending and raises the risk of a run on banks. Consequently, to protect themselves banks curtail the creation of credit out of "thin air".

Under these conditions, further monetary pumping cannot lift banks’ lending. On the contrary, more pumping destroys more real savings and destroys more businesses, which in turn makes banks reluctant to expand lending.

Under these conditions, banks would likely agree to lend only to creditworthy businesses. However, as an economic slump deepens it becomes much harder to find many creditworthy businesses.

Even more, good businesses because of price deflation are reluctant to borrow. Furthermore, because of loose monetary policy the low interest return against the background of a growing risk further diminishes banks’ willingness to expand credit. All this puts downward pressure on the stock of money.

Hence, the central bank may find that despite its attempt to inflate the economy money supply will start falling. Obviously, the Fed could offset this fall by aggressive monetary pumping.

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