Intuitively, printing more money seems like a common-sense solution to alleviating issues of economic inequity and non-access. Counterintuitively, economic reasoning suggests that this isn’t a practical solution to such problems. So, why can’t we print more money? An explainer.
Of late a number of economists have suggested that the government print more money to provide direct cash benefits to poor Indians in distress due to the lockdown. Why can’t this be done, at normal times too, you wonder?
Here is why -
- Why can’t we just print more money to make everybody better off? Simply put, it’s because printing money alone does nothing except increase money supply– leaving the total amount of goods in an economy completely unchanged in and of itself.
- The worth of an economy is not measured by the amount of money circulating in it but the amount of products available or the GDP (Gross Domestic Product), that is, simply, the value of all goods and services produced in a country in a specified period of time. If the money supply goes up, but GDP does not, things can go wrong.
- To better understand this, we’ll have to examine how money comes to have value in the first place.
- On printing more money, consumers in turn gain an increased availability of cash. However, the supply of goods produced hasn’t correspondingly increased, as explained above.
- In response to the increased demand generated by more cash available to buyers, sellers would thus respond by increasing the prices of the goods they sell.
- What the general effect of this would be is that the purchasing power of a currency – the amount of goods a single unit of that currency can be used to buy – would decrease.
- The net effect then lands us back at square one: though people now have more money available to them in terms of the absolute amount, the relative value of this money has decreased so much so as to effectively render people unable to consume more than they would have in the first place.
- The ultimate effect of printing more money is that inflation kicks in, and no real change occurs.
- Increased inflation can have the effect of increasing foreign exchange rates as well. It can also lead to a reduction of exports and possible increase in imports, depending on the extent of the inflation.
- If a country does not have a stable and predictable rate of inflation investors are discouraged to invest in businesses in the country.
- History provides us with evidence of how this works in practice. Take just one example, in response to a number of economic shocks, the Government of Zimbabwe began printing more money to increase the money supply. This resulted in the runaway inflation described above, and in November of 2008, Zimbabwe reported an inflation rate of 79,600,000,000%. Expressed as a daily rate, that’s around 98% per day, meaning that every following day, prices would double.
- Of course, it’s a bit reductive to cite increased money supply as the sole cause of this staggering example of hyperinflation, but the fact remains that the increase in money supply certainly was the driving cause, and such hyperinflation wouldn’t have occurred without the excessive printing of money. (Another contributing factor in this case was price controls on goods– since the cost of production far outpaced prices, suppliers no longer possessed an incentive to produce.)
- In India, the institution possessing the sole legitimate power to print currency is the Reserve Bank of India. This role was given to the RBI by Section 22 of the Reserve Bank of India Act, 1934.
- While coins are minted by the Government of India, it is again the RBI’s responsibility to issue these coins. The rationale behind giving this power to a central bank independent (mostly) from government interference is that a central bank would be better able to manage long-term economic considerations, as opposed to democratically elected governments who may opt to prioritise short-term considerations, especially during election cycles.
- However, the RBI initially played a much larger role in Indian affairs than central banks ordinarily do. The RBI occupied a central role within the planning schemes of early post-independence India (for example, through the government’s mandating of the RBI to provide support to these plans through loans) and was generally seen as instrumental in matters of development.
- The Indira Gandhi administration, across its multiple tenures, nationalised a further 20 banks, in this way giving the government further control over the banking sector through direct control of these banks.
- With the liberalisation of 1991, however, this aspect of governmental control over banking was notably downplayed. Guidelines published in 1993 established a private banking sector, and this private sector came to occupy much of the role in matters of economic development that were previously held by the RBI. The RBI now focuses primarily on the ordinary functions of a central bank, which includes among other things, the printing and issue of currency.
- Two agreements, in 1994 and 1997, completely phased out the automatic monetisation of India’s deficit (which allowed a certain amount of money to be printed as determined by the Government), thus giving the RBI the sole power to determine how much money is printed when. This has had the impact of keeping inflation and inflationary expectations in check.
- Economists who are suggesting that money be printed right now are advocating this simply as a temporary emergency measure and believe that it will not lead to inflation in the short run because the economy is very badly hit. However, even if that were true, concerns remain about whether the government will turn the tap off in time.
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