I have two questions, 1. How does a monetary contraction occur, and 2. Can a monetary contraction occur under a gold baked currency (the amount of gold never really gets smaller)?
A monetary contraction occurs when money is destroyed. If a galleon full of gold is sunk in a battle with pirates, that’s a monetary contraction.
Monetary contractions can occur when the illusion of money is destroyed as well. For example under fractional reserve banking the banks create deposits for more money than there really exists. When this illusion is shattered people have to replace the money that they have lost with real money.
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Monetary Contraction = Less Money. So what causes there to be less money? When people destroy more money than they produce. Central banks, for example, might choose to sell more securities than they buy, thereby causing monetary contraction. If a fractional reserve bank goes bankrupt, all the credit it issued in excess of its savings becomes worthless, thereby causing monetary contraction.
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It can, but it isn’t likely. Monetary contraction generally causes falling prices for goods, which provides an incentive for the producers of money to produce more (since falling prices mean that each unit of money is worth more).