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Elastic currency

19 January, 2016 - 11:14

One way to prevent bank runs is to have a money supply that can expand when money is needed. The term "elastic currency" in the Federal Reserve Act does not just mean the ability to expand the money supply, but also to contract it. Some economic theories have been developed that support the idea of expanding or shrinking a money supply as economic conditions warrant. Elastic currency is defined by the Federal Reserve as 1:

Currency that can, by the actions of the central monetary authority, expand or contract in amount warranted by economic conditions.

Monetary policy of the Federal Reserve System is based partially on the theory that it is best overall to expand or contract the money supply as economic conditions change.

Figure 3.13  
The monthly changes in the currency component of the U.S. money supply show currency being added into (% change greater than zero) and removed from circulation (% change less than zero). The most noticeable changes occur around the Christmas holiday shopping season as new currency is created so people can make withdrawals at banks, and then removed from circulation afterwards, when less cash is demanded.