I understand the concept of creation of wealth through trade, innovation, labor and capital. New value is being added to the economy. Let's imagine for a second that there are no central banks and the money supply is constant. This would imply that even though one can create wealth and add value to the economy the money would just be changing hands, meaning in order for one individual to get richer another would have to get poorer. We all know that in the real world central banks print money (I am ignoring inflation, nevertheless that's not the point) but that isn't the problem as far as I can tell. The current rebuttal of my example is that even though no new money is being created somehow the pie gets larger so everyone can get a larger slice. But how exactly does this process of expanding the pie happen? I can't grasp my head around the idea that the pie can enlarge while the money supply is fixed. I guess that's the same problem mercantilists had back in the 16th and 17th centuries.
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1$\begingroup$ Possible duplicate of How is wealth created? $\endgroup$– GiskardSep 14, 2019 at 7:29
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$\begingroup$ You are mixing up money and wealth. $\endgroup$– user253751Sep 29, 2021 at 10:42
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$\begingroup$ If the economy is growing, but the money supply is constant, then you would probably have deflation. So the value of money increases as the economy grows. (note: this might create other problems e.g. negative interest rates). $\endgroup$– DanielSep 29, 2021 at 12:41
2 Answers
The short answer is that money is not the same wealth. You yourself probably have less money than the value of all the stuff you own. When the economy grows the total amount of wealth grows. (This is usually also accompanied by growth of money, but that is a separate matter.)
(Mostly) ignore money for this growth issue; it's by and large a red herring that's distracting you.
Instead just think of technological progress for instance. Assume everyone is washing their clothes by hand. That takes a fair bit of time. Now someone invents a washing machine. Everyone (who can get a washing machine) will then have more time on their hand to do other stuff, like (say) invent and produce faster means of transportation, saving people time in yet another way and so on. All this is leads to improvements in efficiency (productivity).
If you apply this process of improvements to (say) agriculture, you get to produce more food with the same amount of resources, like with the same manpower and even the land being the same. Now there is a literal pie (of food) that gets bigger, which can feed more people. (The inventions would have to be appropriate, of course, like irrigation, mechanization [tractors etc.], or genetic selection/modification of crops.)
The additional people you can feed in turn can produce more stuff [until you run into limits on natural resources]. This is true even if you don't have technological progress. That's why demographic growth also matters for economic growth.
Of course, money becomes useful as a means of exchanging all this different stuff that people invent and produce, but it's not money that grows the economy, by and large, although financial services (including the basic presence of money) are also a way to make some processes more efficient. As an example of the latter, a loan allows someone to get machinery or even housing up-front, before they've produced enough stuff to pay for the item. That in turn buys them time (in their life) to produce stuff faster (using the machinery sooner rather than later) or even make babies, which would have housing where to live. I.e. financial services can speed up things which otherwise would happen slower or maybe not at all. (Do note that loans are money in the broad sense, in the modern economy; I'm not getting into details on that here; the first link explains it pretty well.)
