The Problem with Printing Money

Readers Comment. The obvious question is why doesn’t the Bank of England just print the money instead of borrowing the money?

Many often ask why government’s don’t print more money to deal with the problem of National debt. The reason is that printing more money doesn’t increase economic output in any way –  it merely causes inflation.

  • Suppose an economy produces £10 million worth of goods. e.g. 1 million books at £10 each.
  • If the government doubled the money supply, we would still have 1 million books but people have more money. Demand for books would rise and firms would push up prices.
  • The most likely scenario is that if money supply was doubled. we would have 1 million books sold at £20. The economy is now worth £20 million rather than £10 million. But, the number of goods is exactly the same.
  • We can say that the increase in GDP is a money illusion. – True you have more money, but if everything is more expensive, you are not any better off.
  • In this simple model, printing more money has made goods more expensive, but hasn’t change the quantity of goods.

Problems of Inflation

Why is inflation such a problem?

  1. Fall in value of savings. If people have cash savings, then inflation will erode the value  of your savings. £1 million marks in 1921 was a lot. But, two years later, your savings would have become worthless. High inflation can also reduce the incentive to save.
  2. Menu costs. If inflation is very high then it becomes harder to make transactions. Prices frequently change. Firms have to spend more on changing price lists. In the hyperinflation of Germany, prices rose so rapidly, people used to get paid twice a day. If you didn’t buy bread straight away, it would become too expensive. This destabilises an economy.
  3. Uncertainty and confusion. High inflation creates uncertainty. Periods of high inflation discourage firms from investing and can lead to lower economic growth.

More on problems of inflation

 

Printing Money and National debt

Governments borrow by selling government bonds / gilts to the private sector. Bonds are a form of saving. People buy government because they assume a government bond is a safe investment. However, this assumes that inflation will remain low.

  • If governments print money to pay off national debt, inflation would rise. This increase in inflation would reduce the value of bonds.
  • If inflation increases, people will not want to hold bonds because their value is falling. Therefore, the government will find it difficult to sell bonds to finance the national debt. They will have to pay higher interest rates to attract investors.
  • If the government print too much money and inflation gets out of hand, investors will not trust the government and it will be hard for the government to borrow anything at all.
  • Therefore, printing money could create more problems than it solves.
  • See also: Printing money and national debt

 

 

Hyper Inflation in Germany during the 1920s

inflation

Inflation was so bad in Germany that money became worthless. Here a child is using money as a toy. Money was used as wallpaper, to make kites. Towards the end of 1923, so much money was needed, people had to carry it about in wheel barrows. You hear stories of people stealing the wheel barrow, but leaving the money.

 

Printing more money is exactly what Weimar Germany did in 1922. To meet Allied reparations, they printed more money; this caused the hyper inflation of the 1920s. The hyper inflation led to the collapse of the economy.

Hyper inflation also occurred in Zimbabwe in the 2000s.

Printing Money and the Value of a Currency

If a country prints money and creates inflation, then there will be a decline in the value of the currency.

  • Suppose inflation in Germany is 100%, and inflation in UK is 0%.
  • This means German prices are doubling compared to the UK.
  • You will need twice as much Germany currency to buy same quantity of goods.
  • The purchasing power of the German currency is declining, therefore the value of mark will fall on exchange rates.
  • See also: Printing money and the exchange rate

Value of One German Mark to US Dollar 1922-23

german-marks-dollar

Hyperinflation in Germany causes a rapid fall in the value of the German mark to dollar.

In a period of hyperinflation, investors will try and buy a stable foreign currency because that will hold its value much better.

Printing Money doesn’t always cause inflation

In a recession, with periods of deflation, it is possible to increase the money supply without causing inflation.

This is because the money supply depends not just on monetary base, but also velocity of circulation. For example, if there is a sharp fall in transactions (velocity of circulation) then it may be necessary to print money to avoid deflation (see: example of US and increasing money supply)

In the liquidity trap of 2008-2012, the Bank of England pursued quantitative easing (increasing the monetary base) but this only had a minimal impact on underlying inflation. This is because although banks saw an increase in their reserves, they were reluctant to increase bank lending.

However, if a Central Bank pursued quantitative easing (increasing money supply) during a normal period of economic activity then it would cause inflation.

90 Responses to The Problem with Printing Money

  1. angela May 11, 2013 at 8:45 pm #

    what if the government print more money, but doesn’t allow the prices to go up even if there is high demand? everyone will still make money and it will incentive others to create business to supply the high demand, or will give the opportunity to other business to sell more, as there will be no other choice for consumers than to get the brands or services that are a available.

    • Doug Foster June 7, 2013 at 8:37 pm #

      In a normal economy (ie., not a recessionary environment, but near full employment) the money supply can only be increased to the extent that we have the productive capacity to meet the increased demand that money would create . If we just print money and have more money chasing the same amount of goods and services, the price must go up (i.e., $10 chasing 10 widgets = $1 per widget, but $20 chasing 10 widgets = $2 per widget). If the government were to impose price controls, either a black market will develop or there will be shortages. As you noted, production could be increased to meet increasing demand, but the money supply can only be increased to the point that production can be increased to meet it. The government can’t control production, it can only print the amount of money necessary to keep prices level given the level of production that exists.

      Right now we are not at full employment, so by increasing the money supply the government is trying to stimulate demand and hence, production. It’s helping, but only slowly and very unevenly. But there is also a risk that if demand picks up too fast relative to production, the fed will need to reverse course and either slow the increase or actually reduce the money supply or inflation could get out of control. It really is a fine balancing act, and not as simple as it might seem.

    • Tom Nguyen June 30, 2013 at 1:27 am #

      Angela, When a capitalism government can control pricing? You need to have a basic understanding of economic, which seems you lack, to make comments on this topic

  2. George Cameron June 14, 2013 at 2:25 pm #

    why doesn’t the uk secretly print US dollars? that way we can get goods in without damaging our own currency.

    • Tom Nguyen June 30, 2013 at 1:23 am #

      You are a very smart man, George. There was nobody in the UK could think of this before…If the US currency can be copied then you will have real money and fake money mixed and it will make the US currency …. VALUELESS.
      Vey smart George, Very Smart. Your education level probably just a hair better than 1st grade.

  3. David Osborne June 14, 2013 at 2:29 pm #

    actually that’s a good idea. let’s do it.

  4. Raimo June 23, 2013 at 6:29 pm #

    The author of the page claims: “The reason is that printing more money doesn’t increase economic output in any way – it merely causes inflation.”

    A flawed claim. Only true, if you create masses of it, and give it away with nothing much in return.

    If gov prints money against labour, it does increase economic output. For example, if gov prints the money to pay wages to gov workers and build infrastructure.

    And further: money is constantly created without any economic output. Banks loan money against PROMISES to pay it back. However, often these promises cannot be kept, and people/businesses/countries get debted. Part of this is because of the system debts some people in anyway as it creates less money than debt, part of it because people just fail. And in addition, “funny money” is created all the time, papers, that the crerators claim have value, but do not. It is probably our biggest bubble waiting to burst.

    And further: If the issuer of the money, can regulate the amounts of money in circulation, like for example government with taxation, there should be no inflation any greater than with current rate of money supply increase.

    And further: the idea of money is not to create economic output. The idea of money is to make it easier to exchange labour. Money is a means of payment. It is labour that creates welfare and wealth, not money.

    Hence, the idea is to get people make labour. And hopefully, labour that benefits the society. If government issued money

  5. Alan July 18, 2013 at 8:27 pm #

    The dollar is not real money…it is only currency. The only reason why it has any value is because we have all decided to give it value. This article also fails to address the fact that the dollar is the world’s reserve currency. Which means whenever we print more dollars, the worlds reserves lose value. When reserves lose value…their exports become more expensive. The only way to counter this is to print more of your own currency to cancel out the effect. So when the US prints money…so must the world lest their exports become to expensive and cause a depression.

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