Why Do We Print Money?

Printing money seems like a no-brainer. Surely it’s extremely obvious that printing money is a recipe for disaster that will result in hyperinflation. Surely the obvious action is to not print money and therefore avoid inflation. Yet every year, every country prints money. Why? Surely the money supply should be fixed. What possible reason could central banks have for risking massive inflation? Why do we print money?

The first and most obvious reason for printing money is to replace old notes in the system. Notes get worn down through use, so it’s necessary to print new ones to replace them. Take a moment to think through why we do this and what would happen if we didn’t. Businesses would start to suffer from a cash flow problem. It would be harder to pay bills and wages, and spending as a whole would slow down. As spending is what drives the economy, this means the economy would slow down. In this sense, printing money is a bit like oiling the gears of an engine, it helps the whole system run more smoothly.

This leads onto the second reason we print money. This is because a growing economy requires it. Think about it, if the economy is getting bigger (through economic and population growth) then there is a greater demand for money. As there are more people, there are more customers. As they are more goods being produced, there must be an increase in the amount of money to buy these goods. If the money supply does not increase, then the economy creates bottlenecks which act as a brake on growth.

Most people assume that printing money automatically leads to inflation without thinking through the steps of how this happens. If you do, you realise there can be exceptions to this rule. Let’s say the government prints a lot of money and puts it into the bank. The bank then lends this money out to people who spend it. Here’s the crucial part. Inflation will occur if demand exceeds supply. If there are more people willing to buy the goods than the shops can sell, then businesses will raise their prices.

However, it should be clear that there is a big hole in this logic. This will only hold true if businesses are at or near full capacity. If there is significant unemployment of resources, then there will not be large amounts of inflation. If a business is struggling and near bankrupt with a large amount of unsold stock, then an increase in demand will not lead to a price rise. If factories are not running at full capabilities but instead are in a slow period, then they can easily increase production in the short run without increasing prices. In other words, if the economy is not at potential output, then printing money may not lead to inflation.

This describes our current situation. The economy is not at full capacity, most businesses are in a slow period. Inflation is very low and demand is weak. Hence the large increase in the money supply in America (called Quantitative Easing) has not led to run away hyperinflation despite the warnings of Austrian Economists. This is because the economy is so weak that it can absorb the increase without resulting in inflation. Even more important is the role of the banks. As I mentioned before, newly printed money is usually deposited in banks. However, if banks are near bankruptcy they will be unwilling to make new loans, so the money supply may not actually increase if money is printed. Why do it then? Well if the newly printed money is held as deposits, it helps the banks starve off insolvency and collapsing, which would bring the rest of the economy down with it.

So is printing money bad then? Well yes and no. As I discussed, there are times (like right now) when it doesn’t lead to massive inflation but can actually help boost the economy and give it a stimulus. So does that mean we can print our way out of recession? Well, no. You see, printing money only works if the economy is under-capacity, at a certain point the limit is reached and after that inflation kicks in. So if a business is operating at 50% of possible production, an increase in demand is helpful and doesn’t lead to inflation. However, once it reaches 90% or thereabouts, it cannot keep up with demand and will have to incur extra costs to meet demand, causing prices to rise. So a little money printing isn’t damaging, but too much is (a rule that applies to most things in life). So what is the right amount? The problem is no one knows for sure and there is a great deal of hit-and-miss in the process.

Even when inflation does occur, this isn’t always a bad thing (I’m referring of course to moderate single digit inflation). It acts as a spur to the economy to keep it going. For example if you know that something will cost more tomorrow than it does today, then you will buy it today. This keeps the shop in business and its staff in a job. The Irish housing market is an example of this system in reverse. House prices are declining, so no one is buying houses (why would you when it will be cheaper next month?). This means businesses in the housing sector go bankrupt because no one is buying, leading to unemployment and economic decline. The lack of inflation causes uncertainty and slow down. What the housing sector needs is rising prices, so although it sounds counter-intuitive, inflation would be a good thing for it. Inflation is also good for reducing the size of debts, which is a good sign in our heavily indebted economy.

Now hopefully, you’re still following me, but you might be thinking about Weimar Germany. Didn’t printing money lead to massive hyperinflation and Hitler? Well, that’s an example of a policy taken to an extreme. I’m not suggesting unlimited money printing, only a moderate amount. Anything taken to an extreme will be disastrous. (And it was the mass unemployment of the Great Depression that lead to the rise of the Nazi Party who were insignificant during the Great Hyperinflation). When you look at examples of hyperinflation in history they almost always happen during times of political instability and war. The chart below lists the worst hyperinflations in history and it is clear that almost all occur when the state was on the verge of collapse, mostly around the time of the First and Second World War and the collapse of the Soviet Union. (Zimbabwe is the main exception in that it wasn’t at war, though it was very politically unstable). Simply printing money by itself is never the sole cause.

The worst cases of hyperinflation in history

The worst cases of hyperinflation in history

So that’s why we print money. It may sound strange and a recipe for disaster, but it is actually a necessary part of the economy, especially in times of recession. When the economy is not fully using its resources, it can provide a necessary boost. So long as it is kept under control, there is no reason to fear massive inflation. So it turns out there is a method in the madness after all.


Filed under Economics

26 responses to “Why Do We Print Money?

  1. We had a politician in Australia (1990’s) so atomically stupid that her solution to the debt problem (which wasn’t a problem) was to just print money to pay it off. The reporter interviewing her nearly fell over in shock. “Miss Hanson,” he asked, “Do you have even a rudimentary understanding of economics?” Her next expression said, “No.”

    • Well that kind of policy is going to be a disaster alright. If its done in moderation by sensible people who have a clue what they’re doing then its not so bad.

      • This woman was an idiot. She was a racist who moved into politics straight from her Fish n’ Chips shop. Literally. She knew nothing and even went on to suggest every man and women (whites only, of course) should get $100,000 from the government (newly printed money) to pay down whatever debts they have.

    • John

      2?s for you ( before I show you how uninformed these comments are)

      What do you think of my idia of printing enough money to double pensioners measly pensions? and possably tripple unememployment benifits?
      And how can we get all govornment debs paid off?
      I don’t mean write the debt off ( that’s not fair to the creditors)

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  3. What about private sector saving? If the private sector saves, say 5% per year (lets say for simplicity, under the matress), does that produce a problem analgous to economic growth? i.e. there is a reducing quantity of money relative to the goods and services on offer. In this case the government has to print in order to offset the savings.

    • Yes there is a whole issue about saving. For simplicity sake, I presumed everyone spent the newly printed money in the example. If the money is instead saved then the effects (positive or negative) will be lessened. Though they will help increase the assets of the bank.

  4. Very nice explanation. I think I wide variety of people reading it will understand.

    I’ve never understood people’s need to classify things as “good” or “bad” when so many things are only good or bad in certain contexts. It puts me in mind of a boyfriend who used to go to restaurants and avoid certain “bad food.” He would not order something he loved and when I asked why he’d say that it wasn’t “bad” for you, or that another food was “good.” When I asked why these things were good or bad, he gave me a blank stare. Finally, I informed him that it was mostly about calories. You see, his doctor had told him to gain weight. His sister thought he was anorexic. He was 5’11” (180 cm.) and weighed 135 lbs. (61kg.) But since more people are overweight than underweight in our society, we talk about “good” and “bad” food in that context. Just the opposite of someone trying to keep weight on.

    Interestingly, everyone described is habits as “austere.”

  5. The money “price” should be fix based on commodity index. If there are no commodity or asset backing up the paper money. Money is just only a bunch of paper.

    Printing money effect always accumulate through time and it not happen in 24 hrs. In short term basis it will help the merchant/bank to gain some asset. In long term basis and nature of capitalist economy; the money that being printed out can not reclaim the original value. This printed money are cheating the people who put their trust on the bank.

    Why I should put the money in the bank if I know the money’s value are decreasing? And in what sense printing money helping the people or public?

  6. Of course, the phrase “printing money” is used only metaphorically. Typically the Fed just types a 1 with a bunch of zeros following it to the account of a member bank and voila, money has been created. There is actually very little currency in circulation compared to the amount of “money.” Plus if the FED adds $10 million to a bank’s account and that bank decides that that amount constitutes a large enough reserve to lend $90 million dollars, that bank will go ahead and create an additional $90 million dollars in loans, again, all by typing some numbers into a computer somewhere. Hell of a flakey system, what?

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  8. GM

    Seems like there’s little reason for this to be tagged with “Austrian economics” either. It’s simple Keynesianism without any Austrian economics being explained, let alone discussed or refuted.

    • Well, I take the initial stance of Austrian economists that printing money will cause inflation or even hyperinflation and show why this is not the case. Sure I don’t quote Mises or anything, but I want to keep it easy to understand while still discussing the issue.

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  11. People always think that if inflation gets too high then they can just print less money, but it is not that simple. Think about Japan. They spend twice what they get in taxes. Only the central bank is buying the government bonds. So, if inflation picks up what are the choices they face? If the central bank stops buying the bonds, the government won’t have enough cash to operate and will fail. But if they let interest rates go up enough that the public will buy the bonds then the government will be even more bankrupt because of the high interest rates, and will fail. So how could they possibly stop printing money? They won’t. Then things fly apart.


  12. Part of a government’s power comes from the ability to print money. Part of the condidence in the money comes from the government’s power. It is natural for the two to go down together. Japan is printing half the money they are spending. If people no longer like their money, the government will be losing power. Of course there will be political stability at the same time. That the political instability and high inflation have not started yet does not prove they won’t.

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