Flip Side of Printing Money

Can we print our troubles away?

Why don’t poor nations print money to get out of debt, or get richer? Why doesn’t the government of a country just “make” more money, whenever needed? Printing money is simple, what happens to the overall value of the notes in circulation, is the worrisome part.

Printing money indeed has its benefits. Essentially creating money and giving it to the people increases aggregate demand, because demand for goods increases as income rises. For example, after the 2008 Global Financial Crisis, countries used quantitative easing and money printing to get their economies moving again. If there is a shortage of money, demand for goods decreases, which means businesses cannot sell enough, or even pay their workers. People cannot even resort to borrowing because banks do not have enough money to lend. Thus a little boost through printing money can be beneficial. However, the amount of money being printed has to be regulated. Just ask Zimbabwe for their opinion on printing vigorously, and they would give 79,600,000,000 reasons to not go down that route.

Zimbabwe’s Hyperinflation Crisis

The cause of Zimbabwe’s hyperinflation was attributed to numerous economic shocks. In response to the rising national debt, the national government increased the money supply, leading to significant declines in economic output and exports, and additionally political corruption coupled with a fundamentally weak economy. The country’s inflation rate for November 2008 was a staggering 79,600,000,000% (essentially a daily inflation rate of 98%!). Prices in Zimbabwe nearly doubled every single day. With the unemployment rate exceeding 70%, economic activities in the country virtually shut down and turned the domestic market into a barter economy.

How does the USA do it?

The only country that can print money to get richer is the USA. This is because every valuable commodity in the world (oil, gold) is priced in the US dollars. The power to actually print money lies with the US Department of Treasury, but the US Federal Reserve can increase the money supply by adding credit to their member’s bank deposits. The Federal Reserve essentially allows companies, banks, and people to borrow, spend and invest more money. They do this in two ways.

Firstly, by lowering the Fed fund rate. The Fed fund is the amount a bank must hold in reserve each night. Banks usually borrow a certain amount when they cannot reach that target. The Fed fund rate is the rate of interest it pays on that amount. By lowering the Fed funds rate, the Fed allows banks to pay less for what they have borrowed, thus allowing them to lend more money out to their customers. Banks would like to lend every dollar they don't have to hold in reserve, so they comply as soon as the Fed funds rate target is lowered. They then lower all their other interest rates, making capital more affordable, so businesses and investors are more likely to borrow. High liquidity spurs economic growth in this way.

Secondly, by implementing Quantitative Easing (QE). In this, Central banks buy long-term securities from the open market in order to boost liquidity and investment. The Fed used QE in response to the COVID-19 pandemic in 2020. The Federal Reserve announced on March 15, 2020, that it would purchase $500 billion in U.S. Treasuries and $200 billion in mortgage-backed securities over the next several months. They expanded QE purchases to an unlimited amount on March 23.

Is it worth it for India?

This sounds like a very safe solution but if the central bank increases money supply (causing inflation) and the economic output does not increase, it could mean catastrophe for the country in question. This is exactly what the RBI is worried about. Increasing money supply will depreciate the Indian Rupee, causing investors to lose confidence in a developing country like India, furthermore, the demand for dollars can increase making the exchange rate unaffordable. The effects of inflation itself are enough to keep the RBI from printing money. There are many, most notably Abhijeet Banerjee (Nobel laureate), Uday Kotak (MD, Kotak Bank) and P Chidambaram (ex-finance minister), who believe that India should print money provided economic output is equivalently increased. They believe that an inflation rate of a little over 4 percent may not harm the economy as much and that India is well placed in terms of output and capacity to tackle rising demand. Ultimately India cannot compare itself to countries like the US and Japan because of the strength of their economies, but it is imperative to be aware of changes in the monetary policy of these first-world countries, especially the United States because they influence the world market and with great power comes great responsibility.

Dependance on the dollar

The extent to which US monetary policy affects the rest of the world was seen recently, when the Federal Open Market Committee, a branch of the Fed, suggested that it might raise the current interest rates by 0.5% in two years. Stocks in Tokyo, India, and the UK tumbled, not because of the fear of rising interest rates, but the fear of what was driving that call: Inflation, and worries that this inflation cannot be curtailed and drastic measures are being taken to handle it. Last year, within 5 months, the Fed’s balance sheet saw an increase of 3 trillion dollars. It has been increasing the money supply to pull the country out of recession, but if the inflation rate goes out of control, not only will the US suffer, but so will the rest of the world because growing demand in the US drives growth in other countries.

The Fed already announced that its median expectation for inflation was about 3.4%, an entire percentage point above its prediction in April 2021. Is it a sign of things to come?

Safe but not secure

The popular belief is that the after-effects of covid 19 have driven production down, but the world economy will bounce back as lockdowns are lifted and global trade occurs more freely. ​​According to the April 2021 World Economic Outlook prepared by the International Monetary Fund (IMF), the global economy is projected to experience a stronger recovery in 2021 and 2022 than indicated in previous forecasts, with global growth projected to increase at a rate of 6% in 2021 and 4.4% in 2022. Even so, one must keep a close eye on the signs. The socio-economic and psychological impact of the pandemic will be prevalent long after the pandemic itself becomes a distant memory. Thus, it becomes crucial to make the correct decisions, right now, to avoid a global recession.