During the great depression the money supply in the US fell by about a third. It is my suspicion that any economy with a falling money supply will generally be doing badly but of course I could be wrong. So I was wondering if the were any examples in any countries (preferably not going back to ancient times) where an economy has had a steadily shrinking money supply but has been doing well with respect to other economic variables like unemployment?

EDIT: I am interested in theoretical answers to this question too.

EDIT: there are multiple measures of a money supply - so I should say that I am referring to any measure which includes notes and coins as well as "demand deposits" a.k.a. "credit" a.k.a. "cheque book money" (so many names for the same thing!).

  • $\begingroup$ There is relative consensus among economists in using M2 as the most representative measure for money supply (Notes and coins in circulation, demand, savings and time deposits). Strictly speaking it is not 100% "liquid" but the "near-liquid" items can easily and quickly be converted to cash. $\endgroup$ – Alecos Papadopoulos Nov 29 '16 at 21:51
  • $\begingroup$ That may be true in the UK, but AFAIK, each country has its own different "M" numbering system. Certainly the UK is different to the US in that regard. $\endgroup$ – Mick Nov 29 '16 at 22:43

Money supply accounts for all the 'money' in circulation in the economy and the money itself has many forms. However, in a nutshell we can understand it as the flow of all kinds of monetary assets in the economy (broad sense of money). The correlation of money supply with growth has been quite contentious. We just lost a very good central bank governor in India because of these differences in opinion. The direction of causality is not so clear. However, many of the researches have had some empirical conclusions that suggest that GDP granger causes money supply and the vice versa is not true.

In short term though, it appears that an increase in money supply leads to higher economic activity (can be easily checked through standard IS-LM or AD-AS models). The long term effects are not so clear.

Having said that the answer to the question is yes, there can be growth even with a reducing or stable money supply. Such a situation would lead to deflationary pressures and possible increase in the velocity of money (faster transactions) in the economy. I don't have any concrete example of this case when money supply is steadily shrinking and economic activity is still healthy and growing. This could be because money supply is usually affected heavily by central bank's tools. And central banks usually would not do this. But there are examples when money supply has remained more or less stable. Such as, U.K in 2013-14 and India in 2015-16(June). In fact in India, money supply slightly decreased during this period while economy overall was in a healthy state.

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  • $\begingroup$ I am not convinced that the UK money supply was stable around 2013/14. Where are you getting that data from? $\endgroup$ – Mick Nov 29 '16 at 15:15
  • $\begingroup$ I was looking at the broad money measure growth from the world bank database. You can check the percentage growth in broad money or the absolute amount. data.worldbank.org/indicator/… $\endgroup$ – Sub-Optimal Nov 29 '16 at 16:45
  • $\begingroup$ The world bank graph looks very different to others I've seen. The term "broad money" is a little vague - so I'm going to look up a graph with a more precise definition - I'll respond again when I've found it. $\endgroup$ – Mick Nov 30 '16 at 8:15
  • $\begingroup$ There was some difference in the data from different sources. That's why I mentioned that I could not find an example for steadily decreasing money supply. Anyways, you can look up for the relevant data. $\endgroup$ – Sub-Optimal Nov 30 '16 at 8:34

The closes answer will be country with extremely low inflation such as Nordic countries, Kuwait, Brunei. But they are not a good example, as the money supply are "balance" with their heavy surplus from natural resources exploitation.

On the other hand, there is plenty of example for "Dutch disease" : excessive foreign exchange that lead to massive future spending with too little on future transformation.

IMHO, there is no "real answer" for this, unless you like in a world with 100% economist. Due to human nature to exploit system, all economy ideology deems broken once it is brought up. Macro manage economy with money supply are one of those. I am not sure what you try to achieve. Inflation is not the silver bullet for "growth". Nor the so call "ripples effect" from the rich really effective.

(update) Keynesianism ciritised European Union below 2% inflation rates lead so "slow growth". Some even suggest country like Greek detach from the Euro and go all out to print money to "stimulate growth". That is a terrible idea of attempt to use monetary policies to solve economy structural issues.

Is shrinking money supply environment painful for an economy?. Even with a clear scope, there is no clear answer.

Some economist argue that "deflation" will cause people "not to spend", to support "inflation" is good because it will force people to spend. This is counter-intuitive against human behavior : human will acquire stuff that they to fulfilled their desires and needs.

There is no concrete example of "retract economy" under stagnation or deflation. Due to diversity of human behaviour, some people will hoard the money and go to graveyard without spending all of it. Some will go grab new TV, subscribe to streaming services, etc.

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Money supplies ebb and flow. And your supposition that a decrease in the money supply is necessarily bad is probably a bit off.

For example, the Fed might shrink the money supply with contractionary policy in an effort to slow and overheated economy. The shrinking of the money supply was triggered by the fact that the economy was very bullish. And I think this is exactly opposite of your point.

Steadily shrinking is different. For example, steadily shrinking a money supply should put constant upward pressure on a currency's value. This might trigger deflation. The intuition is that consumers, knowing their money is steadily gaining value, have a strong incentive to buy tomorrow rather than today.

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  • $\begingroup$ "For example, the Fed might shrink the money supply with contractionary policy" - really? They may have decreased its rate of growth, e.g. from 6% to 4% but to actually make the money supply shrink? When has the fed done that deliberately ever? $\endgroup$ – Mick Apr 4 '17 at 13:56
  • $\begingroup$ What do you think happens when they purchases securities? Sells securities? $\endgroup$ – user12713 Apr 5 '17 at 20:39
  • $\begingroup$ When they sell securities, it acts in the direction of shrinking the money supply, but if the rate of new lending (creating money) is faster than the rate of repayments(destroying money) then it may well be that the overall effect is that the money supply growth remains positive despite the fed's actions. Rather like rowing against a fast flowing stream - if you row upstream at 4mph but the river is flowing downstream at 7mph then you will actually be travelling downstream at 3mph. $\endgroup$ – Mick Apr 6 '17 at 21:55
  • $\begingroup$ You're describing a long-term equilibrium outcome. Everything can adjust in the long run. $\endgroup$ – user12713 Apr 6 '17 at 23:34

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