The Free Market Center
The Free Market Center
The people who hypothesize that the supply of money must increase to service interest payments overlook several significant economic concepts:
The purpose of economic activity consists of the effective and efficient allocation of economic resources that contribute to economic well-being. Money by itself adds nothing to economic well-being.
Money plays the role of a medium of indirect exchange. It facilitates the exchange of economic goods, and money prices provide important information to the market.
Money prices provide information to market actors. Their actions, based on money price information, lead to the effective, efficient allocation of economic goods.
Lending plays an important role in reallocating resources from less productive uses to more productive uses. Money lending simply allows the lending process to operate indirectly, like any other exchange.
Interest reflects the time preferences of economic actors involved in exchanges. Because a good in the future has a lower unit value than an indistinguishable good in the present, people involved in exchanges that span time require more units of the future good in exchange for units of the current good. This difference in quantities amounts to interest. This principle also applies to transactions conducted indirectly through money—including what we refer to as loans.
These key concepts provide the background for the explanation of why the quantity of money need not grow for the payment of money interest.