Does money printing always equal inflation?
By Madhusha Thavapalakumar
Money printing has been a hot topic as of late due to the huge amounts of money printed by the Central Bank of Sri Lanka (CBSL) following the Covid-19 outbreak in the island in March. The scale of money printing has received mixed, but mostly negative, reviews by those who worry about the possibility of it driving up inflation.
Therefore, The Sunday Morning Business delved into the concept and effects of money printing to gather whether Sri Lanka is alone in printing money heavily and whether money printing amidst the economic devastation caused by Covid-19 is different to the conventional understanding of it.
What exactly is money printing?
Money printing in a country simply means printing a currency of a government by an authority approved by the respective government. When the printed money is pumped into an economy to increase the money supply of a particular region or country, it is known as money creation or money issuance.
Another form of injecting cash into an economy is identified as quantitative easing. Quantitative easing is a form of monetary policy used by central banks as a method of quickly increasing the domestic money supply and spurring economic activity, particularly in times of economic crisis. However, further to simple money creation or money issuance, here a central bank purchases government securities from the open market using the money that has been printed in order to increase the money supply and investment. These securities add new money to the economy and also serve to lower interest rates by bidding up fixed-income securities. It also expands the central bank’s balance sheet.
Who prints money in a country?
The money printing authority in our country is the Central Bank under the Monetary Law Act No. 58 of 1949, giving CBSL the authority to do so since its establishment. Before the establishment of the Central Bank, a Currency Board System undertook money printing in Sri Lanka.
The Central Bank prints notes at a British company named De La Rue Lanka plant in Biyagama. The Government of Sri Lanka and De La Rue have an established and successful public-private partnership (PPP) that has been operating for over 30 years and the government owns 40% equity share in De La Rue Lanka Currency and Security Print (Pvt.) Ltd. in Biyagama.
In the US, the Federal Reserve controls money supply within the country as it determines the bills that are printed by the Treasury Department each year. All their paper money is printed by the Bureau of Engraving and Printing in two production facilities in Washington, DC and Fort Worth, Texas. The Bureau is a part of the Department of the Treasury of the federal government.
In India, the Reserve Bank of India (RBI) prints and manages currency while their government regulates denominations to circulate. The RBI is permitted to print currency up to Rs. 10,000 notes. Their currency is printed by Security Printing and Minting Corporation of India Ltd.
Meanwhile in Australia, the Reserve Bank of Australia (RBA) has the sole authority to print currency and in it is being printed at Note Printing Australia Ltd., a wholly owned subsidiary of their Reserve Bank. In the UK, it is the Bank of England (BoE) that has the authority and the money is being printed at De La Rue in England, the same company that prints money for the CBSL.
Recent money printing by these countries
According to statistics of CBSL’s holdings of government securities, the Central Bank has printed nearly Rs. 250 billion this year, with a major portion of this being after the local outbreak of Covid-19 in early to mid-March.
The Federal Reserve is poised to buy up trillions of dollars worth of US Treasuries this year, covering the bulk of the anticipated $ 3.7 trillion deficit.
The country has reportedly begun printing money amidst the pandemic. The RBA admitted that it is now trying to “flatten” bond yields with price controls – meaning it will start buying government bonds when the yields get too high.
The BoE stepped in to buy £ 200 billion of gilts via its quantitative easing programme, a process that amounts to printing more money.
India is now contemplating whether to print money or not to rescue the economy that has been impacted by the pandemic and the world’s biggest lockdown.
The Government defence
In early May, as exclusively reported by The Sunday Morning, Secretary to the Ministry of Finance S.R. Attygalle justified the printing of money to meet financial demands at a time the country was facing its worst-ever economic crisis due to the ongoing coronavirus pandemic.
The Secretary ruled out any negative impacts to the economy in the future as a result of excessive money printing, claiming that it was not only happening in Sri Lanka but also in other countries including the US.
Three weeks later, CBSL was defending its decision to pump money into the economy. Central Bank Senior Deputy Governor Dr. P. Nandalal Weerasinghe in late May stated that it was done to ensure sufficient currency circulation in the country during the coronavirus pandemic. According to him, this decision would provide sufficient liquidity to the banking sector and the public to enable them to conduct transactions and facilitate sufficient currency circulation or ensure adequate cash in hand, especially during the lockdown period.
“Pumping more liquidity into the market, which is not excessive when compared to the overall monetary expansion, will not cause any adverse impact such as overheating of the economy or high inflation,” he added.
According to a study done by CBSL Assistant Governor Swarna Gunaratne, total new money printing in Sri Lanka during the five-year period from 2013-2017 had amounted to Rs. 455.4 billion. New money printing by the Central Bank was a net outcome of changes in net foreign assets or changes in net domestic assets of the Central Bank.
In 2017, the Central Bank injected Rs. 287.5 billion by acquiring foreign assets while reducing money injections through domestic assets by Rs. 203.9 billion, thereby increasing new net money injection to the economy only by Rs. 83.7 billion.
According to Gunaratne, the reduction of money stock through the reduction of domestic assets was done mainly by retiring Treasury bill holdings by the Central Bank amounting to Rs. 304.5 billion and absorbing the equivalent amount of money back to the Central Bank. Accordingly, money printing by the Central Bank was done cautiously with some control to avoid the buildup of inflationary pressures in the economy.
Why is it a dirty word?
Money becomes worthless if too much is printed. This is because increased money supply into an economy increases inflation if the supply is higher than the real output of an economy. This inflation will in turn devalue the currency. If more money is printed, households will have more money to spend on goods and as a result, prices of products will be increased.
Inflation in the US Confederacy is a perfect example of inflation led by oversupply of money. During the Civil War in 1861, the US Confederacy printed $ 20 million notes in May that year and they kept printing money throughout the year which resulted in $ 105 million printed money by the end of 1861.
As a result, paper dollars depreciated immediately, prices of commodities rose, and needless to say it undermined the cause of the Confederacy for the next three years. The inflation in the Confederacy ended in a complete loss of value of Confederate issues and exacerbated the burdens of the war.
Germany is another famous example of hyperinflation led by increased money printing. Following World War I, Germany suffered economic issues. The Treaty of Versailles was the most important of the peace treaties that brought World War I to an end. The treaty required the payment of reparations by the Germans, but the reparations made it impossible for Germany to meet the obligations as they were not allowed to make the payment in their own currency. They had to opt for an acceptable hard currency and printed more and more of it, which worsened rates and shot up hyperinflation.
At its height, hyperinflation in Weimar Germany reached rates of more than 30,000% per month, causing prices to double every few days. Some historic photos depict Germans burning cash to keep warm because it was less expensive than using the cash to buy wood. In 1920, the price of one loaf of bread in Germany was one mark and it went up to four billion.
Similar to Germany, reparation payments led to hyperinflation in Hungary too. Following World War II in 1946, the inflation rate in Hungary exceeded by 200% which equates to an annual inflation rate of more than 13 quadrillion percent. It was so out of control that a new currency system was introduced to mitigate this issue.
When Zimbabwe was hit by hyperinflation in 2008, prices rose as much as 231,000,000% in a single year. Venezuela too faced a currency instability issue five years ago. In 2015, the inflation rate was 181%, again the highest in the world and the highest in the country’s history at the time. The rate reached 800% in 2016, over 4,000% in 2017, and about 1,700,000% in 2018. Several economic controls were lifted by the Maduro administration in 2019, which helped to partially tame inflation until May 2020.
Hyperinflation certainly is not good for an economy. To avoid paying too much in the short term, people will hoard goods at home; stockpiling will result in shortages of goods in the market. Savings of people will begin to diminish and cash will become worthless.
American economists say the recent move by the US to print money after Covid-19 will in turn reduce the value of USD because there is more money than the number of products and services. They added that every fallen empire and every modern government today has always inflated the money supply and the “just print more” attitude has been infectious.
“We believe the Federal Reserve’s large-scale asset purchase plan (so-called quantitative easing) should be reconsidered and discontinued,” economists warn.
To date, the US Government’s deficit is around $ 23 trillion and the interest owed plus the trillions more created essentially creates an everlasting debt vacuum.
Is money printing inherently bad?
One might ask if pumping excessive money into an economy leads to hyperinflation and governments around the world are well aware of this fact, why would anyone want to print money. This is because it is possible to increase the money supply without causing inflation including in a case when the growth of money supply is absorbed in real output.
Swarna Gunaratne in a research paper says that money printing authorities should print money only to match the value of overall transactions in the economy. She added that when economic and business activities grow in a country, there should be an increase in total money supply as well to facilitate such transactions. Therefore, after estimating expected economic growth of a country (in nominal terms) for each year, the monetary authority is responsible for adding new money to the economy only to the extent to meet that amount of growing transactions.
Several governments around the world have been seen printing money this year, especially after the pandemic that has compelled respective economies into recession. As economists say, in a recession, there is spare capacity in the economy. Therefore, an increase in the money supply helps to get unemployed resources used in the general economy. Therefore, in the case of a recession, increased money supply is unlikely to cause inflation.
Tejvan Pettinger, an economic writer at Oxford University, says that depressed economy central banks can increase the money supply without causing inflation and this occurred in the US between the years 2008 and 2014. Alan Shipman, an American economist, says that in 2008, there was the global financial crisis when banks lost a lot of money and couldn’t give it to their depositors when they wanted to withdraw their money. Luckily, most countries have central banks, which helped run the other banks, and they printed extra money to get their economies moving again.
Why is the world on a money-printing spree?
World countries, particularly the aforementioned countries, have been printing money increasingly, especially this year mainly to fight the ongoing pandemic and the massive damage it has caused on their respective economies.
According to the CBSL, Sri Lanka printed money to ensure currency circulation during the pandemic. The reason for the Fed to inject money into the economy is to keep markets under control and provide liquidity. The Fed thus prevents a possible liquidity crisis and contributes to people affected by the coronavirus.
Meanwhile, the BoE has resorted to money printing to help smooth its financing of the dramatic ramping up of spending on measures to support those who are losing income during the Covid-19 lockdown. A professor of economics at Dartmouth College in the US said: “The Bank of England will keep buying gilts until the market calls its bluff, but we are nowhere near that stage.”
India is contemplating money printing to avoid high interest rates that could dampen their economic activities and to ensure credit for the private sector and other borrowers during the pandemic.
India, the UK, and the US are amongst the top 10 economies in the world while Australia is among the top 15 and the comparison of their money printing with that of Sri Lanka might not be a like-for-like comparison given that our economy is comparatively much smaller. However, the Sri Lankan Government itself stated that money printing is widely happening even in countries like the US in defending its money printing.
Economists have maintained that if a country prints a certain sum of money that could match their real output, money printing could be healthy for an economy. However, whether the current level of money printing in Sri Lanka will match its post-Covid real output remains to be seen.