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Does more money always make the economy grow?

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Photo illustration / Rafael Ben-Ari / Chameleons Eye / Newscom

(Read caption) One hundred-dollar bills are shown in this photo illustration. The US government has bolstered the country's money supply, but will that necessarily lead to economic growth?

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Though there has been some anomalies suggesting otherwise, such as the latest ISM manufacturing survey, most U.S. economic indicators suggest serious economic slowdown from what was already a weak recovery.

Yet money supply growth during the latest year has been relatively high during the latest year, largely because of QE2. Given the role that Austrian and Monetarist theories place on money supply in determining cyclical fluctuations, how is it possible for economic growth to slow down even as money supply growth increases?

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Well, first of all, money supply is not the only factor influencing the economy. A lot of other factors, including money demand, demography, tax- and [government] spending policies, foreign business cycles etc. also influence economic growth. Saying that money supply changes could affect short-term changes in the short term is certainly not the same thing as saying that money supply changes is the only thing affecting economic growth and that there should therefore be a perfect empirical correlation. It's sort of how the things you eat influence your weight, but that doesn't mean that there will be a perfect correlation between eating habits and weight, because other factors, primarily genetics and the amount of exercise also influence weight.

And secondly, it is not certain that an increase in money supply will, even in the short term, boost economic growth. It will, if the conditions described in Austrian business cycle theory is applicable. But it might also be the case that it simply bids up prices in general, or the prices of largely imported commodities. If that is the case, then higher money supply growth could lower, and not increase, even short-term economic growth, as for example Zimbabwe experienced during its recent hyperinflation.

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