Does the actual supply of money decrease, or does it merely appear so because money has been pulled into savings? I’m fairly certain that it is the latter, but I thought I should verify.
Money would get pulled out of savings in a downturn, wouldn’t it, as some people lose their jobs, and others pay down debt?
I think a reduction in bank lending (as asset prices drop) lowers the growth of the money supply. Whether it actually turns negative would depend on the severity of the downturn and the extent to which the Fed took corrective measures.
Paying back debt is the only way, that I can think of, to decrease the money supply. But in a downturn, what causes people to pay back debt at a greater rate? Is it just the banks claiming houses/cars/whatever and auctioning that stuff off? In a poor economy I wouldn’t think that that would be a particularly large factor since who would you be auctioning to?
ETA: Or–minor epiphany–say that people don’t pay more to debt, but they cease taking new loans, so all bank movement is unidirectional. Debt payments don’t increase, that’s just all there is. I think that may be my answer.
Two things happen. One, the velocity of money slows down as people and businesses buy & spend less.
And two (as you realized) the net debt does go down as many new projects aren’t started, people don’t buy as many new cars, etc. Meanwhile, most businesses & people keep paying their monthly payment like always, chipping away at principal.
Yes, there are some people who take on new debt by financing their unemployment on their credit cards. As you may recall, the CC companies moved aggressively to chop off a lot of unused credit limit precisely to avoid getting hammered by a burst of growth in impossible-to-collect-later debt. So there’s not as much of this as it first appears.