A few days back, acting union finance minister Piyush Goyal expressed himself favouring printing of currency as a way of deficit financing, citing the example of the US. Dishing out the concept of printing money is not an ordinary one and is alarming.
The concept of printing the currency to fund the budget deficit is toying with the idea of helicopter money – a reference to an idea made popular by the American economist Milton Friedman in 1969. Here the basic principle is to increase broader economic activity and pushing the inflation up by putting more money in circulation in the market.
As printing of money to finance deficit increases inflation and is believed to be an attempt to extract more output in an under performing economy, it is potentially loaded with huge risks. Historically speaking, we don't find a sterling history whenever the governments have printed money to finance their deficits.
In 1920s, Weimar Germany was in grip of hyperinflation for three years. Beginning in August 1921, Germany began to buy foreign currency with Marks at any price, but that only sped up devaluing the Mark considerably. In 1923, the Mark had lost meaning with the exchange rate of one trillion Marks to one dollar. It was simply a financial tornado for Germans.
Zimbabwe too was caught in this precarious situation in the first part of this century. The facts reveal that there was a time when a 100 trillion Zimbabwe dollar bill wasn't enough to buy a bus ticket in the country's capital. And this kind of hyperinflation scenario has gripped Venezuela right now.
These are the instances which show how easily things can spiral out of control when a government prints currency to finance its expenditures. As this helicopter money boosts inflation, increases interest rates and borrowing costs, it then becomes a dire need to print money every year to fund burgeoning deficit.
So, while looking at the experience of printing currency in other countries, it can easily be concluded that such a move doesn't increase economic output in any way, it merely causes inflation. And this increase in inflation is not good for economic health of the country. Government may double the supply of money, but the production of goods remains almost constant. You have more money in the system, but prices of commodities shot up. Precisely, printing more currency makes goods more expensive, but won't change the quantity of goods.
As far as inflation is concerned, it's loaded with inherent problems. It not only erodes value of savings, but reduces resources to save. It triggers increase in prices frequently and discourages investors, which means lower economic growth.
It's a common practice for governments to borrow money through bonds or any other financial instrument. These bonds are considered as safe for investment and it keeps inflation under control. By printing money to fund their expenditures, the inflation will shoot up and this would reduce the value of bonds. Falling value of bonds will keep investors away from bonds. To attract investors in high inflation scenario, the government would be raising interest rates to attract investors. Once inflation gets out of hand, it would be very difficult for the government to borrow money through bonds.
Precisely, printing money could create more problems than it solves. It has huge tendency to trigger collapse of economy. People would lose faith on currency and will store their wealth in foreign currencies.
However, printing money doesn't always cause inflation. As experts point out that the money supply depends not just on the monetary base, but the velocity of circulation (transactions) also matters. For example, if there is a sharp fall in transactions then it may be necessary to print money to avoid deflation. Experts point out that the Bank of England during the liquidity trap of 2008-2012, pursued quantitative easing (increasing the monetary base) but this only had a minimal impact on underlying inflation. This is because although banks saw an increase in their reserves, they were reluctant to increase bank lending.
However, a Central Bank increasing the money supply during a normal period of economic activity then it would cause inflation.
As far as scenario in India is concerned, it's better to nip the evil in the bud. Stop toying with the idea of printing currency.
(The views are of the author & not that of the institution he works for)