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The Supply of Money in the Capitalist Economy Report

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Updated: May 5th, 2022

Money has been used as a medium of exchange for several centuries now. Money has a number of qualities that have made it an effective and efficient medium of exchange. Money is portable, divisible into smaller units, tangible and can easily be quantified (Roy, 2009). It is with regards to this that the world’s economy is quantified in monetary terms. It has long been argued that money is neutral in nature (Minsky, 1986). This fact is attributed to the qualities that money holds. According to this theory, a change in the supply of money plays a critical role in determining nominal factors. However, the same change in supply of money will have no effect in affecting the real variables (Roy, 2009). On these grounds therefore, an increase in money supply within an economy might result in an increase in wages and salaries within the same economy. However, this increase will have no effect on economic development due to the fact that it does not affect the gross national product (GDP) of a given economy in any given way.

However, in present years, the neutrality concept of money has been challenged. In the capitalist economy that the world is currently based on, the supply of money plays a significant role in not only affecting salaries and prices but also the growth of the economy. It is with regards to this fact that the supply of money within most economies is controlled by the central bank. The central bank controls the process of lending to ensure that the money that is available within an economy can sustain its needs. For instance, in the 2008 recession that hit the world, most major economies increased their lending rates as a measure to discourage borrowing (Mayer, 2010). This move has an effect of reducing the money supply within an economy hence eliminating inflation. On these grounds, Friedman and Lucas (1968) concluded that the supply of money within an economy is exogenous.

In a capitalist economy therefore, banks play a critical role in determining the amount of money that is present in circulation. However, just like any other institution, the main aim of a bank is to make profits (Minsky, 1986). To achieve this, banks usually loan money to individuals and organizations that is to be repaid back with interest. The borrowed money is usually invested in ventures that will ultimately result in profits. However, for firms to be sustainable and profitable both in the short run and in the long run, they need to come up with strategic practices that will ensure that they stand at a competitive edge over their rivals. Therefore, firms need to come up with creative and innovative ideas that will increase the ease and efficiency of their operations (Mayer, 2010). Once this is achieved, such firms will enjoy supernormal profits on the grounds that they are a monopoly in their respective fields of operations. This move normally attracts new firms into the industry increasing competition and reducing the profits.

Having all this in mind, it is evident that in a capitalist economy, the supply of money plays a critical role in affecting both normative and real factors of the economy. The supply of money has a direct relationship with the prices of goods and services, wages and salaries paid to employees, value and exchange rates of different currencies as well as the GDP of a given economy. Therefore, stringent measures need to be put in place to ensure that supply of money is controlled to maintain a viable economy.

References

Friedman, M and Lucas, R 1968, ‘The role of monetary policy’, American Economic Review, vol. 58 no. 1, pp. 1-17.

Mayer, D 2010, The everything economics book: from theory to practice, your complete guide to understanding economics today, Adams Media, New York.

Minsky, H 1986, ‘The evolution of financial institutions and the performance of the economy’, Journal of Economic Issues vol. 20. No. 1, pp. 345-354.

Roy, L 2009, Principles of money, credit, and banking, Macmillan, California.

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