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What are some limitations on the money expansion process?

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danaweaver | Student, Undergraduate | eNotes Newbie

Posted February 23, 2011 at 3:22 AM via web

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What are some limitations on the money expansion process?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted February 23, 2011 at 3:39 AM (Answer #1)

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Regarding the process of expanding the money supply, in theory, the government could expand the money supply as much as it wants by simply creating more money.  However, there are at least two limits on this process.

One limit is inflation.  If the government simply creates too much money, inflation will occur.  The inflation will eat away at the value of the money that the government has created and will, thereby, reduce the real expansion of the money supply.

A second limit is the value of the money multiplier.  For example, the government can try to create more money by lowering interest rates so that more people will borrow.  But if people are not willing to borrow (because, for example, businesses are afraid to expand), the multiplier effect for any increase by the government will be reduced.

These factors limit the money supply's ability to grow.

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