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Why does money have value?

The Curse of Inflation


Then why else might we think that our money might not be of value to others in the future? Well, what if we believed our money wouldn’t be nearly as valuable in the future as it is today? This inflation of the currency causes people to want to get rid of their money as quickly as possible. Inflation, and the rational way citizens react to it, causes great misery for an economy. People will not sign into profitable deals which involve future payments because they’ll be unsure what the value of money will be when they get paid. Business activity sharply declines because of this. Inflation causes all sorts of other inefficiencies, from the café changing its prices every few minutes, to the homemaker taking a wheelbarrow full of money to the bakery in order to buy a loaf of bread. The belief in money and the steady value of the currency are not innocuous things. If citizens lose faith in the money supply and believe that money will be worth less in the future economic activity can grind to a halt.

Money is essentially a good, so as such is ruled by the axioms of supply and demand. The value of any good is determined by its supply and demand and the supply and demand for other goods in the economy. A price for any good is the amount of money it takes to get that good. Inflation occurs when the price of goods increases; in other words when money becomes less valuable relative to those other goods. This can occur when:

  1. The supply of money goes up.
  2. The supply of other goods goes down.
  3. Demand for money goes down.
  4. Demand for other goods goes up.

The key cause of inflation is increases in the supply of money. Inflation can occur for other reasons. If a natural disaster destroyed stores but left banks intact, we’d expect to see an immediate rise in prices, as goods are now scarce relative to money. These kinds of situations are rare. For the most part inflation is caused when the money supply rises faster than the supply of other goods and services.

So to answer your question, money has value because people believe that they will be able to exchange their money for goods and services in the future. This belief will persist so long as people do not fear future inflation. To avoid inflation, the government must ensure that the money supply does not increase too quickly.

Thank you for your question.

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