jmherbenerThe production of all goods in the market economy are regulated by profit and loss. This assures efficiency in the use of resources by making production decisions concerning all goods by entrepreneurs. Production of commodity money on the free market economy, for example, would become more profitable during periods of economic growth as demand for money increased. The extra production of money would moderate the rise in its purchasing power, i.e., the extent of price deflation.
If the money stock was fixed in amount, then economic growth could cause price deflation significant enough to make credit contracts infeasible. For example, if price deflation were 5 percent per year and the pure rate of interest were 3 percent then the “real” rate of interest would be a negative 2 percent. But no one will lend at a negative 2 percent interest rate since he could just hold onto his money and have it all in the future.
Contrary to such technical programs for money, when entrepreneurs make decisions about what to offer people as money and how much of it to produce, they can abandon commodities that result in either excessive price deflation or excessive price inflation and adopt more suitable commodities.