Too much state-created money is by definition a bad thing. And so is too little. But how do we know how much is too much and how much too little? The brief dogmatic answer is that we cannot. We can only “suck it and see”. The gold standard may have been excessively maligned by would-be progressive commentators. But paper money has one genuine advantage. While gold, silver and many other precious metals are difficult to eliminate once they have been extracted from the ground, paper money can be annulled. And the edifice of bank credit that rests upon it can, at least, be tapered off.
These basics need to be borne in mind in the arcane dispute about so-called quantitative easing. Old-fashioned textbooks used to talk about “open-market operations”. The theory was blessedly straightforward. Most commercial (or “clearing”) banks, whether by custom or law, held reserves at the central bank which could be converted into cash – notes and coin – on demand. These reserves, plus till money and deposits held by these banks, are often known as “the monetary base”. If the central bank wished to expand the economy it bought marketable securities from the commercial banks. The latter were then flushed with reserves and were able to increase their lending and in the process expand their deposit total.
These activities were known as open-market operations. Thus the quantity of money – or in more recent parlance the money supply – grew and banks became readier to lend to businesses and households. The incentive for the borrower to use the available funds was the resulting drop in the rate of interest.