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Created: Jun 14, 2017

# Money Supply: Its Creation and Destruction

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Money Supply: Its Creation and Destruction by Kaitlynn Gov

The Economic Effect of the Money Supply

If too much money is printed or created, history and economic theory have shown us that prices will increase drastically. When consumers have this much more disposable income, a very small amount of them decide to save extra money. Instead, a large majority of consumers choose to spend this extra cash. Retailers are then be forced to make a difficult decision --
they must either raise the prices of their products or run out of them.

The retailers who run short of their products must then attempt to replenish their numbers, causing producers to face the same decision that retailers had to make. Producers must raise prices or run on a shortage. These producers do not have the ability or the means to create the extra product that the people demand. At the same time, it is also difficult to find labor that will accept a low enough rate of pay to justify the extra production.

This whole situation causes an event called inflation, where an overall rise in prices occurs. Inflation is generally caused by the manipulation of supply and demand. If the supply of money goes up or the supply of goods goes down, major inflation could be caused, but if the two factors are balanced, inflation can be avoided. Two other factors that cause inflation are the decreasing demand of money and the increasing demand for goods.

The Creation of the Money Supply

Most printing is done in order to replace damaged or worn dollars, so printing is primarily for convenience. The Treasury Department has control of the money printing press machines, but the Federal Reserve is the one that manages the capital that is available, including paper money. The money supply is this total amount of capital, and its availability is recognized as liquidity. The Federal Reserve manages the liquidity of the money supply with its monetary policies.

The Federal Reserve prints money when engaging in an expansive monetary policy, or when it wants to increase the amount of capital flowing within the economy. As a result, the Federal Reserve funds and bank rates are lowered, meaning people can borrow money at a reduced cost. This further results in an addition of liquidity, with the same effect as printing money. This high liquidity happens when interest rates are lowered and people can easily exchange credit for cash, while high interest rates will cause the opposite exchange. The Federal Reserve will also print money to encourage borrowing, investing, and growth after the business cycle phase, contraction, which usually leads to a recession.

The Destruction of the Dollar

The net amount of circulating money generally does not change, so, in some sense, money is never destroyed. However, in 2010, cash offices destroyed almost 6 billion notes, the majority being $1 and$20 bills. The U.S.Bureau of Engraving and Printing creates the nation’s dollars, and the U.S. Mint creates the coins. Along with their powers of creation, they also have the power to destroy mutilated bills and send them for disposal. The Federal Reserve also aids in this activity, destroying the currency they want to take out of circulation and replacing it with new bills and coins.

 WORD BANK 1. Economy: a domain that encompasses wealth, goods, services, and how they are produced/used2. Consumers: people or groups that purchase goods and services3. Retailers: businesses that sells good and/or services in small quantities 4. Producers: makes or supplies goods or commodities for sale5. Supply: amount of goods or services available6. Demand: amount of goods or services people are willing and able to purchase7. Inflation: increase in the cost of goods and decrease in the value of money8. Treasury Department: executive department that handles government revenue9. Federal Reserve: the central bank of the U.S. that provides the nation with a stable financial system 10. Capital: wealth like money or other assets used for investment11. Liquidity: the availability and frequent conversion of wealth12. Interest: money paid at a regular rate when in debt13. Contraction: a phase of the business cycle when there is a decrease in economic activity14. Recession: when contraction continues for a certain amount of time 15. Bureau of Engraving and Printing: produces the nation’s paper currency and some coins
B.
Based on the article, what is most likely to cause inflation?
1. a rise in prices due to a retailer's desire to become wealthier
2. a rise in prices due to a high demand for and low supply of a product
3. a decrease in prices due to a lack of money being produced
4. a decrease in prices due to a retailer's overabundance of a particular product