[jmherbener]

If everyone counterfeited $1,000 and spent it in one day, some entrepreneurs would run down their inventories, others would raise their prices, and others would suffer excess demand. Then the new money would be earned by producers and disbursed according to their time preferences pushing up demands more generally. In the end the purchasing power of money would decline and income and wealth would be redistributed. The only difference between a case in which people know and a case in which they don’t know that others are counterfeiting is that if they know, they will attempt to buy things before others and so the impact of the three possibilities will be felt earlier in the day. However, with more money, their demands must increase and with them, prices of goods must go up. (We are ignoring the possibility of building up money holdings.)

In the case of $1,000 disappearing from everyone’s money holdings in one day in which they reacted by reducing their demands by $1,000, some entrepreneurs would build their inventories, others would lower their prices, and others would suffer excess supply. Then the incomes of producers would fall and they would reduce their consumption and investment expenditures according to their time preferences pushing down prices generally. If people thought everyone has less money to spend, they would try to delay the reduction of their demands until after others reduce their demands and so the impact of falling prices would be felt more heavily at the end of the day. However, with less money to spend, their demands must decline and with them, the prices of goods must also decline. (We are ignoring the possibility of running down existing money holdings to fund demands.)