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
Hii guys…
Thanks to all…. i got to know many things… but all got mixed up….
ok your all forgetting one major thing that affects every one in the country.
you all if lucky will retire and you pay into a pension fund correct?
now did you know that 15 years ago a pension pot of £100,000 would buy you a pension of £15000 per year.
now that same pension pot will only give you £5000!
all due to “qe” or for the older people “printing money” strange isnt it they change the name to confuse the youngsters.
also those that are about to retire and say in 10 years time pensions will be so badly affected that the young YOU! will have to pay via tax,s so that the elders can live!.
NOW REMEMBER THIS ITS NOT THE PENSIONERS FAULT ITS YOUR FOR ALLOWING THIS TO HAPPEN!
How is the creation of money by the government any more inflationary than the creation of money by the banks — which is what they do all the time? When my bank gives me a loan of $1,000 they don’t first check the vault to see if they have the money; they simply add it to the balance sheet. *They literally create that money out of thin air.*
When the govt wants to raise money they borrow from the banks who in turn can borrow from the government bank (a country’s central bank). So the govt is loaning money to the banks (essentially for nothing, considering the zero or near zero percent interest rates the central bank charges), only to borrow it back from them at far higher rates. Can somebody tell me why the govt shouldn’t just borrow directly from its own central bank? Not only would it cost the public far less, but the money would actually be returned to the public coffers (instead of to the financial elite). My understanding is that this was the practice in the post-war period through to the 1970s (in Canada at least – where I reside). The result was not only the paying down of the massive WW2 debt with ease but also the ushering in of the so-called golden age – the period of highest economic growth and greatest increase in economic well-being in the history of capitalism.
Can someone please tell me how the financing of public debt through the private sector is something other than a colossal scam to enrich the wealthy elite at the expense of the rest of us? Cuz it sure looks that way…..
hi..
i understand that printing currency does not solve the problem. Still
still If printed money needs to be backed by something like gold. Obviously this will put a restriction on the amount of currency to be printed. And what can this money be backed with?
Or
May be no backing up required. in that case bank is free to print as much as it want (it helps the country or not is another matter.)
Can you clear the smoke to make it clear?
Have a look at http://www.positivemoney.org.uk their videos will explain why the present system of creating money, by banks issuing it as debt, is hugely flawed and makes economies susceptible to booms and busts.
If that truly were the only consideration more books or less books, it seems a locality would be better off having more books since in theory it would support more employment. Those bookmakers would spend their earnings in the locality on goods and services. Those receiving the bookmaker’s money for their goods and services would in turn buy goods and services… and so forth. I’ve heard there is a factor of 7 times, typically, before that money comes to a more restful state. The reverse would be true if demand dropped for books. Means fewer bookmakers were required to make fewer books. Things spiral down if there is no other job for the ex-bookmaker to jump over to.
However, the premise isn’t all that simple either. When higher prices attract more printing of books as mentioned. Eventually that more printing will typically over shoot demand and cause prices to drop. Being raised on the farm, you see this over the years with agricultural products. High cattle(or any other product) prices cause more people to raise them. The product supply grows and the prices come down causing some to raise less of that. Less supply causes the price to rise. All standard economics so far. But what happens to the equation when the bookmaker loses his job and can’t afford the beef even when the cycle of price is at a low? Well it means the supply/demand balance line has shifted downward. What happens when some govt weasel is handed a big bankroll and then gets his committee to allow foreign imported cattle? Shifting to another commodity more important to many because they need it drive to work and heat their homes. What if you have a lot of money and influence the media to make people believe their is a shortage of your product even though your supply is larger than ever? What happens if you can get your middle eastern monarch friends to gin up a war? Unfortunately it is very difficult to cover all aspects of the financial and monetary system without holding something constant so you don’t have to deal with its impacts on the equation.
Is printing money good or bad?
Some may ask what is wrong with printing money in hard times? My question is what is right with it?
Economics doesn’t have to be complicated at all if one could remove corruption out of the picture. How should a small town’s economic differ from that of a small family’s?
A county’s from a state’s or province’ a state from a country? They should all be managed identically to ensure solid economics. Too simplistic? Not at all. All the world’s economic problems would not have occurred and could be solved by not spending more than you have. Inflation occurs because people would rather pay more for something to get it sooner rather than save and buy it when they have the money. When banks are willing to loan most people money, there are more dollars chasing homes and home prices rise. If people waited until they could buy it for cash. Home prices wouldn’t obligate the average working man for the rest of his life. By taking the bait of a loan to get what you want now, you sacrifice your freedom. You feel you have to keep working at that crap job to make the mortgage payments and car payments and credit card payments.
Silly leaders of Countries did the same thing, they took the World Bank and/or IMF bait of money now, here have some more, so much that it will cause inflation and ruin your economy when the loans can’t be paid back. One certain way to keep the competition from another country from emerging. (Argentina some years back comes to mind) He who controls the debt makes the rules. Do you want to be ruled or free? Clearly the citizens of the usa voted in a President who wants to enslave them all. It seems the banker of the world want less freedom. It is definitely much easier to give away than to get back. Why do people not see this? That lack of debt is freedom and debt is control? I have friends who think they are getting informed by watching the TV. Yet who owns the media? It certainly isn’t the free press. Wake up world, shed your debt before its too late (maybe it is too late) or you will be slaves to an unkind master.
YESS THAT IS TRUE
from my own observation printing o money will cause inflation, because if government borrow it can repay back through taxation and other fiscal policy and the economic will stead stable but if government print money their will be nothing to repay and this will cause inflation in the country
The supplier of the answer only supplied us with half of the theory-and it’s even more complicated that that.
According to theory, the higher prices for books should encourage the printing of more of them. Now the more complicated part; when banks don’t lend, the money supply actually shrinks, lessening demand for books, causing the price of them to drop. This encourages the publishers to print fewer books. So our economy has less money and fewer books.
So how are we better off; having more books with somewhat higher prices, or having fewer books with lower prices?