"Doesn't money supply need to grow based on economic activity in the country?" No, this is where we fundamentally disagree. Your statement is "common knowledge". I believe it to be wrong. You can read up on the Austrian view of economics to see where my beliefs lie. I believe that any supply of money will do (within a reasonable amount to make transactions possible) and prices will adjust. I believe it is the flexible money supply that causes the boom times and also the bust. Through fractional reserve lending credit (debt) becomes extended too freely setting up excessive debt and leverage. Low artificial interest rates especially are destructive as it encourages capital (artificial capital - debt) to be employed into enterprises that otherwise would be uneconomical. This leads to overproduction. The boom and easy credit that supports it eventually leads to a bust where the credit contracts and debts go into default because the over investment can not be supported now that the easy money (credit) spigot has been closed off. Easy money = boom that leads to bust. Repeat.

Those that argue that growth in the economy would be stymied if there were not fractional reserve lending. I would agree. Growth would be based on a sustainable level where capitol is allocated by the demand for money which is indicated by the interest rates enterprises are willing to pay. The interest rate they are willing to pay is based on their projected internal rate of return. The Fed stepping in and artificially lowering interest rates short circuits this market force of capital allocation. The Fed makes the boom last longer with lower interest, but only making the bust that much bigger.

In my opinion, fractional reserve lending is the major cause of financial booms and busts. Credit is too easy during the boom so the effective money supply expands too much and effective money supply dries up when the inevitable bust happens and credit contracts. The Fed monkeying with the interest rates just puts the fractional reserve boom bust cycle on steroids. The more they try to manage things, the worse they eventually make the bust.

Those are my opinions. They fall in line with the Austrian view of economics and money supply. These views are held by a very small minority of the public. They do not jive at all with the current Keynesianism thinking of flexible money supply to stimulate the economy when it is in the doldrums and pull in its horns when it is roaring. I think these two different fundamental views, fractional reserve lending and flexible money supply, are where our discussions fall apart and we cease to understand where the other person is coming from. I think there is very little need for the Fed. At most, if they even existed, they would be a stogy institution that would do very little concerning the economy. Market forces would set interest rates and capital allocation.

I'm sure there is plenty there for you to disagree with me on. Most people do.

John