Wednesday, 20 September 2017

Blog

More money? Or more income?

Posted by
October 27, 2014
in Blog

Sorry to say, money and income are not the same thing! Most people think, “I wish I had some more money.” Economists respond, “No, you don’t. If you really wanted more money, you would simply spend less and add to the balances in your bank accounts and in your wallet. What you really mean to say is that you want more ability to spend on the things you want. You want more income, not more money.”

Politically, the problem is that when people in the town hall meetings tell their elected representatives that they want more money, the politician says, “Well, the central bank is in charge of deciding how much money there is, so I will pressure the central bank to create more money for you and everyone else.”

Of course, college sophomores quickly learn that if the amount of money in circulation is doubled the average of all prices will also double—each dollar buys half as much as before, so people cannot buy more things than before. That is, even though everyone has more money, no one on average has more income. In fact, the modern process for creating more money causes uncertainties and inefficiencies in markets for both goods and assets—people cannot accurately know how much relative prices of things are changing. They make mistakes in both consumption and investment decisions, so resources are not allocated as efficiently as when the value of money is known to be stable, so new wealth is not created as rapidly.

Paradoxically to many people, everyone has more of what they said they wanted—more money—but are left poorer than when they had less money! Economists like to use the term “real money balances”to describe the circumstance when the reported nominal stock of money in the economy increases, but the average of the prices of everything also increases, leaving people’s ability to consume little changed.

Some years ago, an article about the nature of money included an insert explaining why it is important for people to understand that “money is not income.” To my surprise, subsequent correspondence revealed that this simple distinction was new to many of the readers. They had grown up wanting to have more money: to earn more money, to be paid more money, to save more money, to have more money to invest. They had accepted the idea that “you can never have enough money.”Yet they were constantly reducing their money balances—by buying things! Clearly, they did not want the money, they wanted the things that can be bought with money!

The lesson is simple: creating more units of money is easy, but that does not create more income or wealth. At best, creating money does little harm; more likely the increasing prices of everything that goes along with excess money creation will leave many—or even most—people worse off. While no one individual may think they can never have too much money, clearly too much money in the economy can be harmful to our economic well being.