Originally posted by KazetNagorra
It's obviously A since you waste fewer resources then (just the ones used to produce the money, if you have it in physical bills, or the administrative cost used to wipe it off computers otherwise). In principle this action should cause deflation, but a billion dollars is such a small amount it's probably not noticable.
Yes, a reduction in the money supply will have a deflationary effect. It would be trivial except in a small enough economy, but I have assumed the thought-experiment is to prompt a discussion of principles.
But I don’t see the wasted resource argument for a., at least unless you’re more specific. Not that there aren’t wasted resources under b., but a reduction in aggregate demand results in wasted resources through their unemployment—e.g., workers laid off, capital lines shut down, investment plans tabled. Anticipated demand is the prime factor when firms make capital investment decisions. Now again, except in a very small economy, I am exaggerating the effects of a billion dollars taken out of circulation (even with the multiplier effect).
The reduction in aggregate demand under a. would be coupled with the deflationary money-supply effect: as interest rates rise, capital investments with a lower marginal return are shelved. The rise in interest rates would dampen demand for interest-sensitive consumer expenditures, such as residential housing , autos, etc. Whether this is good for the economy on a macro level would depend on what the inflation/deflation situation was prior to money being removed from circulation.
I just don’t see how the wasted resources under scenario b. overcome all the effects of a. I could well be missing something, though, and I know that you are economically astute, KN.
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There are some assumptions I am making that are not in the OP: 1. a closed economy 2. a long enough run for multiplier effects to have an impact (without this, e.g., restricting the discussion to the current market period or something close to it, I think KN is right). 3. that the amounts we're talking about are sufficient to have some measurable effect on the economy (perhaps an unrealistic assumption, but necessary, I think, to really discuss the principles). 4. treating the money supply as essentially endogenous, which ignores government monetary policy. 5. ignoring any government fiscal policies, including automatic stabilizers such as unemployment insurance, which could ameliorate the effects I outlined.
EDIT: In response to rwingett's comments, I should perhaps add that I have been assuming a capitalist market economy.