The problem with printing money

Readers Comment. Why doesn’t the Bank of England just print the money instead of borrowing the money?

Printing more money doesn’t increase economic output –  it only increases the amount of cash circulating in the economy. If more money is printed, consumers are able to demand more goods, but if firms have still the same amount of goods, they will respond by putting up prices. In a simplified model, printing money will just cause inflation.

money-supply-inflation

  • Suppose an economy produces $10 million worth of goods; e.g. 1 million books at $10 each. At this time the money supply will be $10 million.
  • 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 in response to higher demand, firms would push up prices.
  • The most likely scenario is that if the money supply were 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 changed the quantity of goods.

money-supply-million-books

Doubling the money supply, whilst output stays the same, leads to a doubling in price and inflation rate of 100%


money-supply and inflation

  • From year 2000 to 2001, the money supply increases without inflation.
  • In 2001, the money supply increases 20%, and the number of widgets increases 20%. Therefore, prices stay the same – the extra money is matched by an equivalent rise in the money supply.
  • It is only in 2003 when the money supply increases from 14,000 to 20,000 that the money supply increases at a faster rate than output and we start to get rising prices.

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, due to inflation, 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, and this is destabilising for the 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 the national debt, inflation could 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 get 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

Hyperinflation 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 and to make kites. Towards the end of 1923, so much money was needed, people had to carry it about in wheelbarrows. You hear stories of people stealing the wheelbarrow, 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 hyperinflation of the 1920s. The hyperinflation led to the collapse of the economy.

Hyperinflation 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 the UK is 0%.
  • This means German prices are doubling compared to the UK.
  • You will need twice as much Germany currency to buy the 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 the 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 the monetary base, but also the 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 the money supply) during a normal period of economic activity then it would cause inflation.

Related

Last updated: 10th July 2019, Tejvan Pettinger, www.economicshelp.org, Oxford, UK

158 thoughts on “The problem with printing money”

  1. If govt prints money and use it to buy imports. The imported goods are used as free raw materials to produce cheap goods some of which are exported. The lower inflation (due to cheaper goods) will boost the exports and counter the downward pressure on currency caused from imports in the first place. It feels like a free lunch.
    Thoughts?

    Reply
      • The money won’t get devalued if it is used for exports.
        Think about it this way..

        Maybe the government borrows 500m dollars for importation of ambulances.
        Why don’t it just print those monies and use it to import those stuff.
        At least the printed money is out of the country and prices wouldn’t necessarily go up.
        And maybe it can reduce it’s national debt.

        I understand that printing more money would cause that currency circulation in the world economy to increase and devalue, but i think it wouldn’t have a major effect if the government introduces policies that would actually cause people outside the country to demand the currency more.
        Example is very good tourism policies and investment

        Reply
    • Money with which you buy imports will again return to you by the same country as the country purchases your products. Just as the case in Iran when the USA imposed sanctions on it. India bought oil from Iran with Indian currency in exchange they bought our agriculture products. So in either way, the money which you print is again getting into the market which makes it surplus indirectly causing higher demand ultimately leading to inflation.

      Reply
  2. I’m in Seattle and here the housing prices have double in the last four years in many parts of the city. In fact it seems housing prices have gone up at least 50% all over the state. Is this due to the Fed and quantitative easing policy of injecting 100s of billions of money into the US economy? In spite of the rapid rise in housing prices salaries have remained nearly the same as they were four years ago except the minimum wage has gone from $8 per hour to $16 per hour. I don’t own a home and am wondering if I should buy at this time or just move to another country?

    Reply
  3. Printing money does not cause broad inflation because production costs keep going down, thanks to technology. Excess money goes to Real Estate, Stocks, and eventually gold. Don’t know how this ends in the long term.

    Reply
  4. Stimulus packages like we are seeing in the US and now also in Australia. This is new additional money printed and created digitally by the oligarch-owned financial institutions.
    The problem I see is that it;
    1. money cost almost nothing to create (made by the private oligarchs either printed or by a few keyboard strokes)
    2. it is sold at full bank note value to our governments treasury (the citizens) to repay with interest
    3. this increases national debt, scarcity and inflation.
    Solution is:
    1. create money and give it to where it is needed ie., as a basic wage for all to live (shelter, food, clothing), to make free all medical, dental, education – so this money circulates to needed infrastructure and industry
    2. people are then able to have time be healthy, study and become more valuable contributors to society
    3. Cap prices of all basic living things and gradually increase to standard of products and services and in-so doing the standard of living for all.

    Reply
    • This is exactly what I’ve been trying to tell people – government just need a firm hand to guide and police the hand outs etc, we are technology advanced now there would easily be systems they can put in place to regulate how the money is spent by the individuals and contain the ‘inflation’ by the supplier

      Reply
      • Agreed. If the velocity and supply of money goes down because 30% are not working then you print that amount fo money and give to those individuals..
        The problem is you incur debt when you print money to balance the book.
        This does not need to happen. The UN creats money and gives it to Individual govts as a percentage of their GDP. This is placed into individual account.s.

        Reply
  5. The value of currency is based on the country’s assets/wealth and it’s health. If more assets are acquired, such as finding more oil, gold, uranium or other precious reserves, then the currency value increases. This also applies to technologies, goods and services manufactured or acquired by such a country. All those things have physical worth, and therefore add wealth and strength to the currency. The value of the currency can be affected negatively if the country’s physical medical health is poor.

    Some countries find reserves and keep quite. When the time arises where that country may profit from a spike in the currency value. The information is released. This allows such a country to devalue other country’s currency so they may take advantage of other countries.

    Sometimes currency values are just an illusion due to a delayed reaction while it stabilizes after a major global economic upheaval, or countries printing more money adds to the illusion of higher currency values. The illusion continues until the rest of the world finds out. then the currency value stabilizes to a real value, generally lowering the country’s advertised currency value.

    Banks are very good at creating illusions of currency value. For instance they can have lot’s of debts that are unpaid from lending money. The banks then sell those debts for real money to debt collection agencies. There are laws that state that a bank can lend more money than they have, and therefore create debt. In the end the Banks make money from imaginary money and sell it for real money. The debts that are being sold and resold eventually find there way to some poor individual who is stuck with it thinking it was an investment.
    A debt is just a contract that enables the “creditor” holding such contract, to claim the money stated on the debt. If debts are sold for half price, they make an attractive incentive for the owners of the debt to make money by collecting such debt. This is a dangerous way to run finances as it can cause stock market crashes, and global financial disaster such as we have seen in the past.

    Reply
  6. The present economic system of the consumerist society we live in is mostly a ponzi scheme, its time for a reset…everything that has a beginning has an end.
    Its time for a new system and a new society (not an economy)
    Id rather live in a society that is portrayed in Star trek not Blade runner

    “Heaven is place with no advertising”

    Reply
    • Yes, I agree – utopian maybe but a fiction attempting to address human greed.
      As stated in the above article:
      “…in response to higher demand, firms would push up prices.”
      Why?
      This, in economic terms, has never been adequately explained to me. It’s as if there is an invisible, irresistible, never to be argued with force that just compels firms/business owners to increase prices, “We can’t help it, it’s not our fault!”
      I don’t buy it – it’s just plain greed.
      Toilet paper anyone?

      Reply
  7. hmm i dont understand. so lets say im a country like malaysia now

    https://www.businessinsider.sg/malaysia-unveils-rm250-billion-economic-stimulus-package-to-help-nation-cope-with-covid-19-fallout

    which apparently is in debt of over 1trillion RM but yet is able to unveil such a big budget. can this country just print 250 billion and support this budget?

    Assuming these people dont spend these monies and hoard it inside their bank accounts or spend as per normal as like when they are still drawing their salaries, albeit lesser. will this impact the economy? since their isn’t an over excessive amount of the said currency flowing around?

    Reply

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