Credit crunch and the money supply

Mark Carney, the governor of the Bank of Canada, and recently appointed to the Financial Stability Board, to oversee international financial reform has made the news by pointing out there may be a new wave of credit tightening as a result of the European debt crisis.

When bankers and economist worry about a credit crisis they are talking about a decline in money supply.  This is because banks create money when they make loans.  If they don’t make loans there will be less money around.

In a declining economy there are two things to note.

First, as we feel the squeeze from an unsustainable use of resources, there will be need for less money in the economy. Otherwise there will be inflation.

Second, if the money supply declines more than is needed, then there will not be enough money for the exchange of the goods and services we are capable of producing.  This too could contribute to the recession.

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