Inflation Feedback and Competition for Purchasing Power

By definition, any true monetary “authority” possesses legal and operational means to limit the economy’s aggregate money and credit to any quantity it deems appropriate (as explained in Chapter 3). In reality, however, political, social and economic realities circumscribe monetary authorities’ powers, in greater or lesser degree. The tighter the credit supply, the harder it will be for firms to do business and meet contracted commitments. Monetary authorities always have three fundamental missions. One is to maintain the value of the currency, by limiting its supply. The others are to maintain credit conditions adequate for “normal” business and an adequate international reserve stock. Over the longer run these objectives coincide: stable currency is essential for sound credit, while business stability and reserve adequacy are essential for a sound currency. On a day-to-day basis, though, the monetary authority’s peculiarly difficult task is to set the money supply small enough to meet the price-stability objective but large enough to meet the credit- and reserve-adequacy objectives.