There are different ways to explain it, I will use the simplest one. This formula essentially says that goods get exchanged for money in the monetary economy:
M(oney)*V(elocity)=P(price)y(output)
Lets say you destroy 50% of M overnight. This will have a huge effect on Py, because prices can not change that quickly, you will have a falling output.
Now its pretty easy to keep M constant (as long as politicians can not fund their pet projects with printing). The problem is that Velocity (another word for money demand) is not at all stable. So if something happens that for some reason effect money demand, it will have a effect on Py, that is price or output. In the short term, prices can not change, thus output suffers.
Every good monetary system has a way to balance this out. Note issuing private banks (before central banks) would automatically do this because when the noticed increasing demand, they would have to raise the gold reserve ratio. If the notice a decrease in demand, they could decrease the gold reserve ration and thus make more profit.
A modern day central bank will say that they target inflation. So they attempt to make P stable (predictable) and let the market (supply side) determine the output. If there is a huge crash in V the central bank should be able to see this and before it affects P or y to much, adjust it back. They are making it quite hard on themselves. Many people now call for targeting NGDP, that just means MV.
Bitcoin is fine as long all your doing is making payments, once you have multi layered complex economies that depend on the correct working of the prices system to aggregate information threw the system you will have constant problems. Price systems are the secret sauce that make markets actually work as well.
M(oney)*V(elocity)=P(price)y(output)
Lets say you destroy 50% of M overnight. This will have a huge effect on Py, because prices can not change that quickly, you will have a falling output.
Now its pretty easy to keep M constant (as long as politicians can not fund their pet projects with printing). The problem is that Velocity (another word for money demand) is not at all stable. So if something happens that for some reason effect money demand, it will have a effect on Py, that is price or output. In the short term, prices can not change, thus output suffers.
Every good monetary system has a way to balance this out. Note issuing private banks (before central banks) would automatically do this because when the noticed increasing demand, they would have to raise the gold reserve ratio. If the notice a decrease in demand, they could decrease the gold reserve ration and thus make more profit.
A modern day central bank will say that they target inflation. So they attempt to make P stable (predictable) and let the market (supply side) determine the output. If there is a huge crash in V the central bank should be able to see this and before it affects P or y to much, adjust it back. They are making it quite hard on themselves. Many people now call for targeting NGDP, that just means MV.
Bitcoin is fine as long all your doing is making payments, once you have multi layered complex economies that depend on the correct working of the prices system to aggregate information threw the system you will have constant problems. Price systems are the secret sauce that make markets actually work as well.