Inflating the Money Supply
In Gilligans Island Economics — Auto Bailout, I described what’s wrong with simply throwing money at an economic problem. Now let’s talk about where that money comes from. Remember, the Skipper and Gilligan have been making a tidy living building huts for everyone, but now the market for huts is slowing down (everyone has one) and the Skipper is worried about where Gilligan will find the money to buy coconut cream pies.
Thurston Howell III proposes a bailout. He’ll take an extra $100 out of his trunk of money and give it to the Skipper and Gilligan, and that way they have extra time. Suppose that the Skipper is “generous” and Gilligan gets $30. Gilligan immediately runs to Mary Ann and offers her $10 for every pie she makes for the next week (Gilligan is skinny, but he can really eat). The Professor also likes coconut cream pies, so where he normally gives Mary Ann $2 for pies during the week, he ups his offer to $4. Mary Ann ends up making more during the week, and she’s able to offer more money to Lovey Howell for the shell necklaces she makes, forcing Ginger to pay more as well.
You can see where this ends up. The castaways started their economic system fairly: Mr. Howell gave $100 to each castaway, so the total economy on the island was $700. Now with the bailout there is an extra $100, for a total of $800, floating around. Prices will go up as people find they have more money to pay with.
The Ripple Effect
So who benefits and who suffers? Gilligan and the Skipper obviously benefit — they get an extra $100 of free money to split between them. Everyone on the island suffers to the extent that they are holding dollars. If the Professor happens to have $200, because he gets paid infrequently and needs to have cash reserves, while Mary Ann keeps only $20 on hand because she makes money on pies every day, then the Professor suffers ten times the damage that Mary Ann does.
The Real World
The situation is the same in the real world economy. Banks create money the way Mr. Howell did every time they issue a loan: the borrower has the money to buy a house (for example) while the person who deposited the money in the first place still has access to their account. The amount of money is tracked in terms of the actual money floating around and the money that is available in one way or another. A better description is in the wikipedia article on money supply.
The money supply can increase (somewhat) harmlessly as the economy increases — if an extra hundred castaways washed up in the lagoon the island economy would experience a significant decline in prices as the 700 circulating dollars distributed themselves among 107 people. In a circumstance like that it makes sense for Mr. Howell to pull more money out of his trunk.
Last week the Fed increased the money supply by over 1 trillion dollars. To misquote Everett Dirksen (who apparently never actually said it), “a trillion here, a trillion there, and pretty soon you’re talking about serious money.” Actually, a trillion is serious money by itself. It’s about the same as the above scenario on the island. We should expect to see prices increase significantly as that extra money hits.
The Fed has the ability to increase the money supply arbitrarily. There is no one beneficiary, but a range of them, in the form of banks and financial institutions. Certainly not you or me. The Fed have been going to the trunk and pulling out extra money for nearly one hundred years, and often spending it on nothing more useful than coconut cream pies.