The problem with printing money

Readers Comment. 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. 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 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

Doubing 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 20001, 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 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 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 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 2017, Tejvan Pettinger, www.economicshelp.org, Oxford, UK

By on July 7th, 2017

126 thoughts on “The problem with printing money

  1. we understands that currency equal to output ,if we print money just for import ,its means such print money does not have base output ,so impact will same with excess currency chasing fewer goods.

  2. How would the government get newly printed money into the public’s hands? Increase govt payments without an expected increase in output? Would increasing public assistance type programs be a serious path to hand out new money? What would be the point? With more money available to spend wouldn’t output chase demand and minimize inflation or is greed the over riding effect? Yes in the short term output versus demand lag would result in a short term inflation but in the long run available resources would catch up with output and inflation would come back to neutral. I’m trying to explain this to my kids who like the idea of free money, go figure. Thanks

  3. What if
    1. money gets printed people get free money.
    2. prices are controlled.
    3. Govt pays off it debt
    4. Govt debt balance sheet is set to zero.

    Any thoughts

    1. Momin,
      1) This is too simplistic, but the above article touches on this. Printing money to give away for free has far reaching impacts ie. there is no output associated with the increase in money, thus the money not worth as much, causes distrust in the system, debt becomes worthless. (once the credit, or debt, of a country crumbles, everything collapses
      2) Supply and demand controls prices. giving away free money immediately impacts prices. there is no “controlling” it unless you do so artificially
      3) With money that is worth less? “money” is only worth something if it corresponds to “value creation”. Fiat money such as the US dollar is worthless without the belief that there is a fundamental growth (or at least stabilization) of the economy behind it
      4) Everything is based on credit. This wouldn’t ‘improve’ anything

  4. The world debt is so great now that the banks will be forced to keep printing money. Eventually hyperinflation will start followed by a massive depression & economic collapse, as in the weimar republic in 1921. Only WW2 brought europe out of recession in 1939, with re armament. Again today civil unrest will follow,then revolution . Bitcoin is no answer its just converting $ to another currency to buy the same goods & services. But keep quirt about it the banks & politicians dont want you to know whats going on.

  5. So according to Mr Google the planet’s population grows by an estimated 80 million per year.

    I think Govts print or electronically produce money at will because all of those new people will need to be fed clothed housed provided with social security etc.

    Inflation is a scam. We should be able to put a price freeze on products whenever we want in order for everyone to become more comfortable in their present financial situation.

    We live in times where food is bountiful. African and other poverty stricken countries need to be assisted by all other civilised nations to share in the bounty that we all enjoy and to help build better infrastructure and to educate them on family planning.

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