The Fed’s Reluctance to Print Money

Readers Question: Is the spectre of inflation the only reason the FED doesn’t simply print the US out of its economic troubles? By print, I mean at least print enough to pay down the debt to a manageable level, or create a major business incentive program using printed cash.

Certainly, a big fear of the Fed is that printing money to reduce the real value of debt would cause inflation. Why printing money can cause inflation. | see also: Problem of Printing money

Apart from printing money, other reasons to be concerned about printing money could include:

• Credibility. Central Banks place a lot of importance on the idea of ‘credibility’. The argument is that if they get a reputation for always keeping inflation low, then it becomes easier to achieve this objective. If you look at the case of the ECB, I think they would find it very difficult to pursue a policy which is associated with higher inflation. The ECB has a long history of targeting low inflation – above all other macroeconomic targets. A key reason for the ECB to avoid printing money would be to avoid this loss of credibility.
• Value of Currency / Dollar. Another potential problem of printing money is that it is likely to cause a devaluation in the dollar. Printing money either causes inflation or threatens future inflation. Either way, an expansion of quantitative easing is likely to devalue the dollar. The Fed may be reluctant to see a devaluation of the dollar because it will increase the price of imports, increase inflation and reduce living standards. However, you could also argue that in a recession, a devaluation of the dollar would help the economy. A devaluation would make US exports more competitive and enable the economy to grow faster. I don’t think the fear of a devaluation in the dollar would be a major deterrent.
• Bond Bubble. If the Fed printed money to buy government bonds. The price of bonds would rise. This may cause a bond bubble (the rapidly rising price of bonds). This bond bubble could burst when the Fed have to reverse the policy of money creation and stop buying government bonds. (Do we have a bond bubble?)

Recently, Paul Krugman has criticised the Fed for not doing enough to stimulate the economy. He argues that the Fed is nervous about sufficient monetary loosening because of fears over inflation from Congress. He also makes the point that the FED has a dual mandate over low inflation and output.

The Fed has a dual mandate, employment and price stability. Its own projections show high unemployment persisting for years and years, inflation running below its target — and realistically its inflation projections are too high while its unemployment projections are too low. There is no rational argument I can see for not going all out with monetary stimulus. (link)

Related

see also: Problem of Printing money