[Explained] Why Printing Money is not an Ideal Solution in Economy?

Some Burning Questions related to Printing Money

• Why poorer nations can't just print more money and become rich?

• Will printing more money help revive Indian economy?

• Why can't RBI print unlimited currency?

• Why the government can’t simply cancel its pandemic debt by printing more money

• Why can't print more Money to Eradicate Poverty?

• Why don't govt Print money to finance Deficit?

At some point of time you may have thought these Questions, but do you really know the Answer? Answer to all these Questions based on Printing more money is same, so lets understand why printing more money to fight various issues is not an ideal Solution in Economics and what are the aftereffects of Printing more money?

With the government borrowing heavily to fund its debt or fight any social evil like Poverty or to fund its previous debt, it has been suggested it could simply cancel its debt by printing more money. That sounds like an attractive idea, but it is one that would have seriously adverse consequences.

Relationship between money supply and inflation

Imagine a country ruled by a dictator. He decides to buy off his rivals thus increasing his spending to fulfill his own personal agenda. Where does he get all his money from?

When you rule an entire nation with an iron fist, you have absolute control over the Central Bank and the money printing machine. He decides to turn on the machine and print as much currency as he wants. 

Now we need to consider the fact that the total number of goods in his nation is constant and the only thing that has increased is the money supply. The real problem starts here.

If you print more money, the households will have more cash and more money to spend on goods. Firms will respond to the increased money supply by jacking up the prices resulting in inflation. The value of the currency will start decreasing as more money will be required to fetch the same amount of goods or services.

Perils of printing money

Suppose only two persons are residing in a country with an income of Rs 10 p.a. each, and the only good produced in the economy is 2kg of rice. At present, suppose 1kg rice costs Rs. 10. So, both the persons earning Rs. 10 each can buy 1kg of rice each and feed their families.

Imagine, all of a sudden, the government starts printing more money, and then, each of them has Rs 20. But the supply of rice remains the same, i.e., 2 kg. With more cash in hand, the demand for rice has gone up (each of them can now afford the entire 2 kilograms of rice).

The shopkeepers know the fact that now each of them can shell out Rs 20 for rice. So, to meet the entire demand, they’ll double the price of rice. So, now a Kg of rice would cost Rs 20! And that’s how more money can lead to a rise in prices, besides other effects.

Therefore, the printing of money should always match the total production of goods and services in the country, or else inflation can destroy the economy.

Major factors to be considered while printing new currency

Inflation

Inflation is the increase in the prices of goods and services over time. It's an economic term that means you have to spend more to buy a gallon of milk, fill your gas tank or get a haircut. Inflation increases your cost of living as it reduces the purchasing power of each unit of currency.

And excessive money in supply can actually lead to ‘hyperinflation’. History says it all. In the year 2008, Zimbabwe witnessed 2,31,000,000% inflation! Meaning a sweet that cost them $1 in 2007 would require $231 Mn in 2008. Ridiculous, isn’t it?

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.

Gross Domestic Product

GDP is the final value of the goods and services produced within the geographic boundaries of a country during a specified period, usually a year. GDP growth rate is an important indicator of the economic performance of a nation. 

GDP is another critical factor that affects the amount of money to be printed in the economy. The government prints money of the same value, as its value has gained into their economy or, in a simple way, GDP. So, rising economic productivity - GDP increases the value of money in circulation since each currency unit can subsequently be traded for more valuable goods and services.

The point worth noting is, the government gives people the same amount of physical currency as a medium of exchange as the value it is getting in return from GDP and inflation.

Minimum Reserve System

Currency issued in the country relies upon the reserves RBI has with it after meeting all its liabilities.

Now by reserves, it means the following:

         1. Bullion reserves

         2. Foreign exchange reserves

         3. Balance of Payment (BOP) only receivables.

In India, currencies are supplied by the RBI with the backing of bullion reserves, foreign exchange reserves (foreign currencies), and Balance of payment(only receivables). For the new issue of currencies, the RBI follows the Minimum Reserve System at present. The (MRS) Minimum Reserve System has been followed since 1956.

Under MRS, the RBI has to keep a minimum reserve of Rs 200 crore comprising gold bullion and gold coin, and foreign currencies. Out of the total Rs 200 crores, Rs115 crore should be in the form of gold bullion or gold coins. The purpose of shifting to MRS was to expand the money supply to meet the increasing transactions in the economy.

RBI follows some principles or rules for issuing new currencies based upon the people’s economic growth and transaction needs.

There is one More related concept which you should Understand i.e. Deficit Financing. 

• Many a times you will read that Printing Money has been suggested as a measure to Finance Deficit.

What is Deficit - A budget deficit typically occurs when expenditures exceed revenue.

What is deficit financing?

Deficit financing means generating funds to finance the deficit which results from excess of expenditure over revenue. The gap being covered by borrowing from the public by the sale of bonds or by printing new money.

Why we need deficit financing

For developing countries like India, higher economic growth is a priority. A higher economic growth requires finances. With the private sector being shy of making huge expenditure, the responsibility of drawing financial resources rests on the government.

Often both the tax and non-tax revenues fail to mobilize enough resources just through taxes. The deficit is often funded through borrowings or printing new currency notes.

What is “direct” monetization of deficit?

Imagine a scenario where the government deals with the RBI directly — bypassing the financial system — and asks it to print new currency in return for new bonds that the government gives to the RBI. Now, the government would have the cash to spend and alleviate the stress in the economy — via direct benefit transfers to the poor or starting construction of a hospital or providing wage subsidy to workers of small and medium enterprises etc.

In lieu of printing this cash, which is a liability for the RBI (recall that every currency note has the RBI Governor promising to pay the bearer the designated sum of rupees), it gets government bonds, which are an asset for the RBI since such bonds carry the government’s promise to pay back the designated sum at a specified date. And since the government is not expected to default, the RBI is sorted on its balance sheet even as the government can carry on rebooting the economy.

This is different from the “indirect” monetizing that RBI does when it conducts the so-called Open Market Operations (OMOs) and/ or purchases bonds in the secondary market.

Has India ever done this in the past?

Yes, until 1997, the RBI “automatically” monetized the government’s deficit. However, direct monetization of government deficit has its downsides. In 1994, Manmohan Singh (former RBI Governor and then Finance Minister) and C Rangarajan, then RBI Governor, decided to end this facility by 1997.

Now, though, even Rangarajan believes that India would have to resort to monetizing the deficit. “Monetization of the deficit is inevitable. Such a large increase in expenditure cannot be managed without monetization of government debt,” he said recently.

Is Printing Money logic is always wrong?

No exactly, it depends on the Circumstances in which it is being used

Former RBI governor D Subbarao recently said that India’s central bank can directly print money and finance additional spending by the government. However, Subbarao added that it should only be done if there is absolutely no alternative.

Subbarao clearly mentioned in an interview with news agency PTI that India is “nowhere” near such a scenario. He suggested that the government can consider Covid bonds as an option to raise borrowing as part of budgeted borrowing to deal with the economic slowdown during the second wave.

“It (RBI) can (print money) but, it should avoid doing so unless there is absolutely no alternative. For sure, there are times when monetisation despite its costs - becomes inevitable such as when the government cannot finance its deficit at reasonable rates,” Subbarao said.

"We are nowhere near such a scenario," he added.

He Said "There is no question that India must borrow and spend more to fight crisis such as Covid-19; that is a moral and a political imperative. But New Delhi should not forget that its bruising balance of payments crisis in 1991, and a near-crisis in 2013, were, at heart, a result of extended fiscal profligacy"

Reference Article : IE, IndiaToday