Analyzing a New Banking Policy's Implications

Last week Phil introduced us to the island of Coinucopia, where only a limited supply of gold coins could be used to keep the economy functioning. But the island is suffering from very slow economic growth. Steve explains how any innovation, that sees new products come to market, will see the same money chasing more goods, so prices will necessarily come down. That’s until the island decides to allow bank loans. At first, they only allow banks to loan out coins that have been deposited with them, but eventually they realise the potential of introducing bank notes. Now they have growth, but how do they curtail inflation? They’ve read Milton Friedman and believe an increase in money automatically creates inflation. But maybe he was wrong!

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