James d. Gwartney

ELEMENT 2.5
A stable monetary policy is essential for the control of inflation, efficient allocation of
investment, and achievement of economic stability.

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98
investing will involve additional risks, and transactions that take place over time (such as
payment for a house or automobile) will be fraught with additional uncertainty. When the
value of money is unstable, many potentially beneficial exchanges are not made and the gains
from specialization, large-scale production, and social cooperation are reduced.
There is no mystery about the cause of monetary instability. Like other commodities,
the value of money is determined by supply and demand. When the supply of money is
constant or increases at a slow, steady rate, the purchasing power of money will be relatively
stable. In contrast, when the supply of money expands rapidly compared to the supply of goods
and services, the value of money declines and prices rise. This is inflation
(?)
. It occurs when
governments print money or borrow from a central bank in order to pay their bills.
Persistent inflation has a single source: rapid growth in the supply of money. The
money supply
(?)
 is the total of the nation’s currency, checking deposits
(?)
, and similar sources
of payment
(34)
 held by individuals and businesses. When that supply increases faster than the
growth of the economy, the prices of goods and services will rise.

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99
Exhibit 7: Monetary Growth and Inflation, 1990–2014
Average Annual Growth Rate
of Money Supply (%)
Average Annual Rate of
Inflation (%)
Slow Growth of the Money Supply
Sweden
3
2.3
United States
3
2.1
Switzerland
3.4
1.1
Singapore
3.5
1.4
United Kingdom
5.5
2.7
Central African Republic
6.4
3.6
Canada
7.5
2.1