Interesting Thought Question on Money Creation

Document created by Eric Chiang on Dec 16, 2015
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This is an example that I’ve adapted from an original story posted by Eric Keetch in the Financial Times on August 12, 2009 titled “Quantitative Easing: It’s So Simple!”

 

Suppose Will gives his wallet containing $100 to Alex to hold while he works out. During Will’s workout, Alex uses the $100 to pay his mechanic who fixed his scooter. The mechanic then took this $100 to his vet to pay off his past due account from services previously provided to his dog. The vet then used the $100 to pay Alex for money she owed him for tutoring her in economics. Alex then puts the $100 back into Will’s wallet. After Will’s workout, Alex returns the wallet to Will without him ever realizing that money was temporarily missing.

 

Although the same $100 was used without Will’s knowledge, everybody’s debt has been settled. How much money was created out of thin air?   

 

  1. $300
  2. $200
  3. $100
  4. $0

 

Answer: $300. Although the same $100 was used, the money was able to satisfy three separate $100 transactions. The same outcome would have happened if everyone: Alex, the mechanic, and the vet, each had their own $100 and used it to settle their debts. Instead, none of the three had any cash, but instead “borrowed” Will’s $100 and used it three times without him knowing.

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