Why central banks avoid printing more money?

Many often ask why government’s don’t print more money to deal with the problem of National debt. The reason is that printing more money doesn’t increase economic output in any way -  it merely causes inflation.

• Suppose an economy produces Rs 10 million worth of goods. e.g. 1 million books at Rs 10 each.
• 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 firms would push up prices.
• The most likely scenario is that if money supply was doubled. we would have 1 million books sold at Rs 20. The economy is now worth Rs.20 million rather than Rs 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 change the quantity of goods.

Problems of Inflation

Why is inflation such a problem?

1. Fall in value of savings. If people have cash savings, then inflation will erode the value  of your savings. £1 million marks in 1921 was a lot. But, two years later, your savings would have become worthless. High inflation can also reduce the incentive to save.
2. 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, people used to get paid twice a day. If you didn’t buy bread straight away, it would become too expensive. This destabilises an economy.
3. 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 national debt, inflation would 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 gets 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.

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