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 –Â 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 still have the same amount of goods, they will respond by putting up prices. In a simplified model, printing money will just cause inflation.
Video explanation
How printing money causes inflation – Example
- 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.
Doubling the money supply, whilst output stays the same, leads to a doubling in price and inflation rate of 100%
- From the 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?
- Fall in value of savings. If people have cash savings, then inflation will erode the value of their 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.
- 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 that 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.
- Uncertainty and confusion. High inflation creates uncertainty. Periods of high inflation discourage firms from investing and can lead to lower economic growth.
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 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 German 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
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.
Real Life example of Money Supply and 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 and the willingness of banks to lend. For example, if there is a sharp fall in transactions (velocity of circulation) then it may be necessary to print money to avoid deflation,
In the liquidity trap of 2008-2012, the Federal Reserve 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. In 2020, quantitative easing was pursued and a year later, inflation in the US rose. (though inflation also rose due to higher oil prices)
QE caused big increase in bank reserves at Bank of England, but limited impact on money supply and inflation. However, in 2021/22, inflation did pick up (primarily because of cost-push factors) but also strong demand at end of covid.
Related
Last updated: 26th July 2022, Tejvan Pettinger, www.economicshelp.org, Oxford, UK
About The Author
Money is scam plain and simple.
So why should any government borrow money when it can just print it ? Well regardless of borrowing it or printing it , it still inflates the economy that either receives the lent cash or prints the cash. However they get it , its inflation. Like a Balloon, its getting bigger. Now, you have too ask, why borrow it all when you can print it. Exactly why why WHY ? To keep you going to work and not fucking rioting in the street. Now that everyone is slowly working out that the money supply is a scam, watch them nuke everything and come up for air 12 months later. Back to reality. So now that you have realised that dumping money into an economy inflates its supply and devalues its worth, have a think about what giving 500 million dollars does to a small country if you give it AID $$$. So 50 countries donate 500 million dollars each once or twice a year to say Indonesia, no wonder their economy is worhtless , the other nations are deliberatley keeping it poor buy over inflatting its money supply in AID money.
So next time you hear on teh radio that someone donated some buck$ in AID , realise its a trick. And how exactly do they send one country Aid $$. How does America give American Dollars to Haiti when they have Haitian curency with prince pawpa printed on it. Antoehr good question ” me ” , do they type it into the IMF computer and spit out some hot haitian money. YEP !!!! Economic warfare. So anyway back to money . So does anyone else realise that China is busy printing money and just buying up fucking Europe. NOt bad for a guy that finished school at year 10 and I failed. Oh look at me Im Colonel Ghaddafi , Im going to print up some money and buy France. Whos going to stop me , how can they stop me, wait , who will stop me ? Does the IMF have and the world bank have an army ? Holy crap batman , people have been printing loads of money not backed buy anything but swiss chocolate and noodles and gone and bought up nuclear weapons and sharp point sticks , and worse still, they used credit and promised to pay us back in paper. OKay seriously, we had better print some BONDS and issue those straight away. INSERT MASSIVE LAUGH AT THE DUMB PEOPLE HERE *****
printing new money is somewhat destructive bcz i we are nt increasing the output level then new money willl increase the prices of goods in the economy which leads to the inflation….
Any nation should go printing the currencies based on demand supply theory.
Value of goods worth is the equivallent of currency printing volume. Anything less or more will lead to deflation or inflation effecting the currency value.
It is like in physics “every action has a counter action”, It is like in Accounts ” every debit has a credit’. It is like in Maths “every positive number has an equivalent negative number”
At macro level, whatever we do any action will circle and end up at the origin with same level of questions again.
Philosophically speaking economic is also like the life….
….
Nice, JC. Most of your comment I liked. I have trouble with: “…borrowing from the central bank (i.e. having money printed for them.)” and “private sector demand for credit will determine the size of the money supply.”
It seems to me that you are confusing money and credit. Any private sector “money” that costs interest and/or must be paid back, is CREDIT.
Any chance you would visit my blog & leave MMT links or info? What you said here is better than the hour I spent on Warren Mosler’s Dallas address. Thanks, bud.
Art
The argument given in this article is like this:
1. ‘Printing money’ [this is actually just crediting accounts at the central bank] increases the money supply.
2. Increasing the money supply increases demand.
3. Faced with increasing demand, firms will only increase prices (inflation.)
4. Therefore, printing money causes inflation. QED.
The logic makes sense, the problem is the 1st and 3rd premises are rather contentious. I’ll start with the 3rd premise because it is the easiest to explain.
Faced with increasing demand, a profit-maximizing firm will either a) increase prices until demand = supply or b) increase production until supply = demand. With enough competition, firms will prefer b) since a slight increase in prices will drive almost all of their customers to a competitor. If one bookstore charges 10$/book and the one next door charges 8$, you won’t see 20% of customers switching, you’ll see nearly 100%. Bookstores will thus rationally order more books, so increasing demand will not just simply cause inflation (as long as machines are underutilized – i.e. there is unemployment and underemployment.)
The first premise is a bit more difficult. Any time someone lends money to the government by buying bonds, the central bank debits the bondholder’s bank and credits the government account. The government then spends that money by crediting banks and debiting it’s account. The net transaction is 0$ being created. When the government ‘prints money,’ on the other hand, it debits its account (which can overdraft indefinitely without default. Government cheques don’t bounce) and credits banks. This leaves excess reserves in the banks which they will lend out to other banks (driving the interest rate to the deposit rate, which might be 0%) or keep to back private loans. The article assumes that banks have a given amount of reserves and private entities will instantly take out loans until the bank meets its reserve ratio. That’s like saying that you will always max out your credit card.
The reality is different, though. Banks lend to whoever is credit worthy and at the end of the day make sure they have enough reserves. They do this by either borrowing from other banks or by borrowing from the central bank (i.e. having money printed for them.) So private sector demand for credit will determine the size of the money supply, not how much money is in central bank accounts (though the interest rate can affect this.)
Ultimately, the central bank prints money anyways to allow the money supply to accommodate increasing trade. So the operational reality of the government spending without issuing debt isn’t much different from spending with debt issuance, except for the fact that interest rates are driven down. The central bank can choose to control the interest rate directly by setting the deposit rate, or it can let it fall to 0% and the government could use taxation to control inflation. Using taxes to cool off the economy has the advantage that 1) it can be targeted to specific sectors and 2) the voters ultimately decide what the trade-off between standard of living and price stability should be, rather than unelected central bankers. There’s also the advantage that the economy can be allowed to grow to its full real potential without fear of having to ‘pay back’ anything.
If you want to learn more, this is called Modern Monetary Theory (MMT).
All of this sounds like a bunch of crap, we print money and then we borrow money, now you tell me, I make sand for the beaches around america but I also borrow sand from other countries, it doesn’t sound educated, the bottom line america stop listening to these pulpits or so economic advisors, like all of them they talk out the side of there mouth, we print up money and we can’t fix our problem and then you say inflation stop it prices would not go up and the money will be put back into the economy so all that crap you are saying is a bunch of b.s. people think about it, we print up money why borrow, because they don’t want us to ask questions.