Mises Wire

There Is No "Optimum" Growth Rate for the Money Supply

Most economists hold that a growing economy requires a growing money stock on the grounds that growth gives rise to a greater demand for money that must be accommodated. Failing to do so, it is maintained, will lead to a decline in the prices of goods and services, which in turn will destabilize the economy and lead to an economic recession or, even worse, depression.

Since growth in money supply is of such importance, it is not surprising that economists are continuously searching for the right, or the optimum, growth rate of the money supply.

Some economists who are the followers of Milton Friedman—also known as monetarists—want the central bank to target the money supply growth rate to a fixed percentage. They hold that if this percentage is maintained over a prolonged period of time it will usher in an era of economic stability.

The idea that money must grow in order to support economic growth gives the impression that money somehow sustains economic activity. However, money's main job is simply to fulfill the role of the medium of exchange. Money does not sustain or fund economic activity. The means of sustenance, or funding, is provided by saved final consumer goods. By fulfilling its role as the medium of exchange, money just facilitates the flow of goods and services between producers and consumers.

Historically, many different goods have been used as the medium of exchange. On this, Mises observed that over time

there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.1

Through the ongoing process of selection over thousands of years, people settled on gold as their preferred general medium of exchange.

Most economists, while accepting this historical evolution, cast doubt on the idea that gold can fulfill the role of money in the modern world. It is held that, relative to the growing demand for money because of growing economies, the supply of gold is not adequate.

Furthermore, if one takes into account the fact that a large portion of gold mined is used for jewelry and various industrial purposes, this leaves the stock of money almost unchanged. In this way of thinking, the free market, by failing to provide enough gold, is likely to cause money supply shortages. This, in turn, runs the risk of destabilizing the economy. Hence most economists, even those who express sympathy toward the idea of a free market, endorse the view that the money supply must be controlled by the government.

What Do We Mean by Demand for Money?

Much of this theory is built on a misconception. Demand for money is not demand for a larger amount of money. Rather, when we talk about demand for money, what we really mean is the demand for money's purchasing power. After all, people do not want a greater amount of money in their pockets; what they want is a greater purchasing power.

In a free market, in similarity to other goods, the price of money is determined by supply and demand. If there is less money, its exchange value will increase. Conversely, the exchange value will fall when there is more money.

Within the framework of a free market there cannot be such thing as "too little" or "too much" money. As long as the market is allowed to clear, no shortage or surplus of money can emerge.

Once the market has chosen a particular commodity as money, the given stock of this commodity will always be sufficient to secure the services that money provides.

Hence, in a free market, the whole idea of an optimum growth rate of money is absurd.

According to Mises:

the services which money renders can be neither improved nor repaired by changing the supply of money….The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.2

How can we be sure that the supply of a selected commodity as money will not start rapidly expanding because of unforeseen events? Would it not undermine people's well-being?

If this were to happen, then people would probably abandon this commodity and settle on some other commodity. Individuals who are striving to preserve their lives and well-being will not choose a commodity that is subject to a decline in purchasing power as money.

Printing Money to Save an Unstable Banking System

So, the problem does not stem from the fact the market supposedly requires more money than is available.

Under our current system of constant new injections of money, it appears that the central bank is "managing" the monetary system and enhancing the economy by increasing the money supply. The truth, however, is something else: initially, the present paper monetary system emerged because central authorities made it legal for the overissued banks not to redeem paper certificates into gold. Nowadays, this system must be sustained as a fractional-reserve fiat-money system. To manage the system, the central bank must constantly create money "out of thin air" to prevent banks from bankrupting each other during the clearing of checks.

This leads to persistent declines in money's purchasing power, which destabilizes the entire monetary system.

Since the present monetary system is fundamentally unstable, the central bank is compelled to print money out of thin air to prevent the collapse of the system. (Again, the present monetary system emerged because the government allowed banks to issue certificates unbacked by gold). It does not really matter what scheme the central bank adopts as far as monetary injections are concerned—it can print money directly or it can act in the money markets to target interest rates. Regardless of the mode of monetary injections, the boom-bust cycles are likely to become more ferocious as time goes by. Even Milton Friedman's scheme to fix the money growth rate at a given percentage won't do the trick. After all, a fixed percentage growth is still money growth, which leads to the exchange of nothing for something—i.e., economic impoverishment and boom-bust cycles.

What about keeping the current stock of paper money unchanged? Would that not do the trick? An unchanged money stock will cause an almost immediate breakdown of the present monetary system. After all, the present system survives because the central bank, by means of monetary injections, prevents the fractional reserve banks from going bankrupt.

It is therefore not surprising that the central bank must always resort to large monetary injections when there is a threat of various political or economic shocks. How long the central bank can keep the present system going is dependent upon the state of the pool of real savings. As long as this pool is still growing, the central bank is likely to succeed in keeping the system alive.

Once the pool of real savings begins to stagnate—or, even worse, shrink—then no amount of monetary pumping will be able to prevent the implosion of the system.


Since the present monetary system is fundamentally unstable, there cannot be a "correct" money supply growth rate. The present monetary system emerged because central authorities allowed and encouraged the practice of issuing banknotes that were not fully covered by gold. In order to sustain this system the central bank was introduced. By means of ongoing monetary management, the central bank’s job is to prevent banks from bankrupting each other during the clearance of checks. Whether the central bank injects money in accordance with economic activity or fixes the money supply growth rate, it continuously destabilizes the system. To make the system truly stable is to permit the free market to take over. In a truly free market, there is no need to be concerned with the issue of the "correct" money supply growth rate, and no institution is required to regulate the supply of money.

  • 1Ludwig von Mises, The Theory of Money and Credit (Irvington-on-Hudson, NY: Foundation of Economic Education, 1971), p. 45.
  • 2Ludwig von Mises, Human Action: A Treatise on Economics, scholar’s ed. (1949; Auburn, AL: Ludwig von Mises Institute, 1998), p. 421.
Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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