1273626 rohit sharma f2 Q23

 Why do governments borrow money and pay interest when they could print all the interest-free money they need themselves?

Introduction

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 £10 million worth of goods. e.g. 1 million books at £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 £20. The economy is now worth £20 million rather than £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.

Conclusion

Printing money by a government, might not lead to inflation, if that government handles that printed money wisely. Take the US and other Western economies that are in trouble today because of the credit failure by banks and financial institutions.
If I were one of those governments looking to get out from under these financial problems by “printing” my way out I would do it this way to solve the problem and prevent any form of inflation that might result from that “printing”.
First, the money that I “print” I would give directly to the “people” in the form of a 33 year interest-free loans limited to $400,000 dollars per. Instead of giving it to any industry or business. This way would get the money into the economy quicker, more efficiently and have a better affect on the economy than going through the regular business cycle and hope they lend it out.
This method lets the borrower pay-off all his interest-burdened monthly debt: mortgage, credit cards, student and auto loans etc. Lowering the borrowers monthly costs substantially allowing him to either save or spend that positive differential created by ridding himself of the interest on his debt and the extention of his principal out over 33 years. While at the same time re-capitalizing those finacial institutions that held that debt. This would keep government out of business’s business and solve two problems using the same dollar a two-for-oner.
To prevent any inflation from this printing the government, as those loans are repaid, would take that money out of the economy. And the banks, having received a large influx of capital, would only lend out what they would have been repaid over the year had nobody defaulted on their debt.
Though trillions were printed only a 1/33 of the money would be affecting the economy at any given time. So, at most, inflation would be around 3%. Had the money been borrowered we be paying about 6% compounding for years.