Evolution of money and the growth-inflation relationship 

Money is a social arrangement that emerged through an evolutionary process to facilitate economic transactions. Exchanges can occur through barter, credit or money, but money became dominant because it reduces transaction costs and makes trade more efficient.

Historically, many societies used commodities such as gold and silver as money. These items had intrinsic value and were also used in jewellery and industry. However, because their supply was limited and uncertain, economies gradually shifted from commodity standards, such as the gold standard, to paper currency.

Modern money must possess certain characteristics. It should be portable, standardised, durable and divisible. Advances in printing technology allowed paper currency to meet these conditions, making it the most widely accepted form of money.

However, the usefulness of paper currency weakens when economies experience high inflation. In such situations, people often prefer foreign currencies such as the US dollar, either officially or unofficially.

Today, most countries operate under a fiat money system, where paper currency is accepted as legal tender for settling debts and paying taxes. Central banks are responsible for issuing and managing currency. Public confidence in money is crucial because currency functions as a public good that supports trade and economic activity. But inflation, political instability and economic uncertainty can weaken that confidence and encourage people to seek alternative assets.

The interaction between money supply and money demand ultimately influences the price level in an economy. Excessive growth in the money supply tends to raise prices. When central banks lose control over money creation, inflation accelerates and money loses its effectiveness as both a store of value and a medium of exchange.

As economies grow and transactions become more complex, financial systems also evolve. The rise of electronic payments, digital banking and credit systems reflects increasing demand for more efficient transaction methods.

Digital money is therefore not a replacement for the monetary system, but an extension of it.

Money remains the most liquid form of asset, even though it typically generates little or no return compared to other financial assets. Its usefulness explains why barter systems have become rare in modern economies.

Even during periods of high inflation, money continues to function as a medium of exchange. However, the demand for money depends on several factors, including income, wealth, returns on alternative assets and economic uncertainty.

The interaction between money supply and money demand ultimately influences the price level in an economy. Excessive growth in the money supply tends to raise prices. When central banks lose control over money creation, inflation accelerates and money loses its effectiveness as both a store of value and a medium of exchange.

Although electronic payments and digital financial services have expanded rapidly, paper currency remains widely used. Demand for cash and demand deposits remains strong because people value liquidity, convenience and anonymity.

While electronic money is likely to become more common, it is unlikely to replace paper currency entirely in the near future.

The importance of money in modern economies was explained by Harvard economist Gregory Mankiw, who argued that money enables specialisation and trade by eliminating the inefficiencies of barter. Without money, economic transactions would become far more difficult and costly.

Money growth and price stability

The relationship between money growth and inflation remains one of the central concerns of monetary policy.

Monetary economists generally argue that there is an optimal level of money supply that allows economies to function smoothly without generating excessive inflation or deflation.

For central banks, the key policy question is determining how quickly the money supply should expand in a growing economy.

According to classical monetary theory, if price stability is the primary objective, money supply growth should broadly match economic growth adjusted for the demand for money.

This helps explain why some rapidly growing economies can experience relatively low inflation despite strong money supply growth.

China provides a notable example.

From the late 1990s, China experienced rapid monetary expansion while maintaining comparatively low inflation. This was largely because economic reforms increased the demand for money and financial services at the same time.

Structural changes in the Chinese economy created new demand for household savings, consumer finance and business transactions.

Three major factors contributed to rising money demand in China: increasing household income and wealth, growing demand for savings to purchase housing and consumer goods, and the financial needs of small entrepreneurial businesses.

The Chinese experience highlights an important point in monetary economics: inflation cannot be explained by money supply alone.

Changes in money demand, structural transformation and broader economic conditions also play a major role in determining inflation outcomes.

This is why the relationship between money growth and inflation continues to remain a major area of research and policy debate.

Akhand Mohammad Akhtar Hossain is the chief economist at Bangladesh Bank.

Disclaimer: The views expressed in this article are the author's own and do not necessarily reflect the position of The Business Standard.