Money Demand

   The Law of Supply and Demand applies to money as strongly as it applies to any other product or service. Last time, we looked at the effect of money supply on the overall economy. Today, let's take a look at money demand.
   An increase in the supply of money can drive down interest rates -- the cost of borrowing money -- but if demand remains slack, a nation can find itself wallowing in cash that sits idle. And with interest rates on savings accounts below 1 percent, there's something to be said for stashing cash in a mattress rather than lending it to a bank. An alternate is using what spare cash people have to pay down high-interest credit card debt.
   Money is a liquid asset, and unless it flows, the body politic becomes inert, like a person with low blood pressure -- there is no incentive to move. Without movement, atrophy sets in, and the economy remains weak -- a psychological as well as physical depression in the body politic.
   Today, despite the ready availability of money at low cost, the economy remains in a psychological as well as an economic depression, drowning in a sea of cash, caught in what John Maynard Keynes called a "liquidity trap."
   While the supply of money as increased, demand for it has failed to respond to the lowest interest rates in decades. Indeed, money demand has continued to fall.
   What does this mean? Traditional monetary policy -- increasing the money supply to boost the economy by lowering interest rates -- has not worked. Despite the extremely low cost of borrowing, investors, bankers and businesses remain worried about the risk of expanding capacity or increasing production in fear that consumers will not buy. Consequence: Continuing recession, if not full-blown economic depression.
   There may have been some recovery in the stock market, and housing prices may have stabilized, but until confidence returns to investors, bankers, business executives and consumers, they will continue to hold on to their cash reserves, strengthening the bottom line against fear of an impending calamity.
   Moreover, this fear reinforces itself, further endangering the overall economy. It's worth remembering here the words of Franklin D. Roosevelt in the early 1930s: "We have nothing to fear but fear itself."
   Conclusion: If monetary policy has not worked, it's time for fiscal policy to take charge, stimulating the economy by increasing spending. And if business will not and consumers cannot, government must.
   By the way, economists have devised yet another formula for measuring the economic health of a nation, this one using Money supply and its movement, or Velocity, as a base. It looks like this:

MV=PQ

   Calculating the Money supply times its Velocity equals the Price times the Quantity of all goods and services, a rough equivalent of Gross Domestic Product (GDP).
   But that's a topic for another day.