By: Econoobics
Have you ever thought that a country could become rich by just printing more money? But why wouldn’t they do it? This idea of printing more money makes a lot of sense, because we use this paper which we call money to buy all sorts of stuffs that we can think of, ranging from necessity items such as food and clothes to luxury goods such as expensive tablets and jewelries. What that means is that the government can just ask the central bank to print more money so that the government itself can pay civil servants higher salary and invest in the country’s physical capital, including roads, bridge and irrigation. With great amount of money comes great power for the government. Wouldn’t it spur economic growth and development much faster? Eventually, everyone is wealthier and can relish a better quality of life on this wealthy island. This is one perfect scenario. I for once asked myself this question and the quest of finding a simple explanation led me astray. In other words, I couldn’t find the right answer to explain it. So I asked that particular question to a friend of mine and he could explain it in a much better way than I ever could. So now I am willing to explain it in a more convincing and simple way than he ever could.
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So let’s analyze the question together, shall we? Is it true that making money out of thin air, that is printing money, can make a country become rich at an instant? To answer this question, we have to ask ourselves what factors determine a country’s prosperity. In a fancy language or technical term, we need to understand the source of economic growth of a country. From the previous article, we learn that economic growth is the increase in output including goods and service within a specific period. Basically, the vast amount of outputs produced (cars, electronic devices, agricultural products, home appliance and other goods and services) is what makes a country rich and grow. To be more precise, it is the level of productivity, labor and capital with which a country can utilize to create goods and service for the people. These are the three main sources of economic growth. We should try to think of the economy as an apple tree which gives us apples to consume. The more the apples grow on the tree, the more we have apple to eat. With our below example, you will see that having a vast amount of paper that is money would not bring about such determinants of economic growth and definitely would not lead to prosperity. We will have a further discussion on the sources and determinants of economic growth in the future topics, but for the time being we will focus on everyone’s favourite topic — Money. (Almost everyone loves money, right?)
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The above paragraph may sound somewhat confusing, so let me draw a simple example to better your understanding. Suppose that I was employed by the central bank of a country called Richland as the country’s Chief Economist and with my brilliant idea to boost prosperity on this peaceful island, I would adopt what economists calls an expansionary monetary policy, which means printing more money, so that the government can finance its huge amount of public expenditure to implement its 10-Year-Leap-Forward Strategic Plan. Our first priority is to increase the salary scale of our hardworking civil servants (police, teachers, ministers and other government officials) so that they can have more money to spend. After all, printing money is not a serious hiccup, because what we need are just ink and paper. At the end of the month, after our civil servants receive their increased monthly payroll, it’s time to let the spending spree begin. Everyone is better off now, so what we do with our money is spending and allocating some of the income for saving. For my case, the first thing that I would do is going to a Mercedes car dealer to order a new Mercedes-Benz S500. Then I would buy a new convertible laptop, buy a new phone, buy new clothes, order fresh organic farm products and other sort of things that I could think of. Now not only I who can afford a Mercedes-Benz S500, but also my colleagues, my friends, my teachers and my doctors can also afford it as a result of the abrupt and massive increase in their income. The question facing the car dealer now is that with this excess in demand for Mercedes sedans, should the car dealer raise the price of the car to maximize his profit or sell it at a normal price? Well, the answer is a no brainer. The car dealer would simply raise the price and sell out all of the cars. Still despite the extreme pricing of the luxury sedan, people are still queuing to buy a Mercedes and the car is now in a huge shortage (Assume that Mercedes is produce in Richland). To meet with this demand, the car factory needs to speed up its production of cars, but producing cars is not the same story as printing money. Cars take a lot more inputs before it can be produced. Those inputs include factory, assembly line, labour, wage, machine, know-how technology and the quantity of output that is able to be produced is limited. With this huge shortage in car and explosive demand, the price of the car definitely will skyrocket. This is only one story for a car company. How about the market of phones, clothes, food? The same story goes and price will certainly hit the ceiling, because production of these outputs could not meet with the excess of demand driven by the hike in monthly salary. After all, the capability of a country’s to produce goods and service is limited. This capability depends on its factor of production which are capital, labour and productivity. In contrast, the printing of more money did not help bolster the productivity of the economy, modernize the capital and upgrade the skills of the workers in order that more output can be produced. Let’s get back to our analogy of an apple tree. Our apple tree produces the same amount of apple for the consumers.
The aftermath of my great vision is the overall level of massive price increase within each sector of the economy which economists call hyperinflation. So are we better off? Say yesterday my salary was 1$ and I could buy an apple (real fruit not a tech product) for just $1. This morning my income is increased by 100% thanks to the Leap-Forward-Strategic Plan, so now I have $2 which I expect to buy 2 apples. But to my surprise the grocery owner tells me that the apple’s price is now $2. So with my increase in income, I still can only afford 1 apple. This is by no means I am richer whatsoever. I think with some of my examples you may probably have an intuitive feeling of why more money in each and every people’s pocket does not bring about prosperity as we wish. Our example of printing more money to massively raise the monthly salary of our government’s civil servants certainly does not spur economic growth but contrastingly results in unintended consequences that is a total catastrophe in the economy. Our story could go on and on. The price of a kilogram of rice may be 1,000,000 riva (a make-up currency) or a kilogram of sugar may cost 500,000 riva. It simply illustrates that our money is seriously devalued and the amount of money that is enough to buy a piece of bread yesterday may not be able to buy same piece of bread today. To sum it up, the increase in the money supply of the government only increases money in our pocket but does not increase the level of productivity of the factories or farms to produce more output to meet with our insatiable demand. In contrast, the over supply of money pushes the economy in a total chaos with extreme increase in the price level everywhere.
You may think that my example is just an imaginary situation and would never ever happen in real life. History taught us that the countries that defy the Principles of Economics often pay a heavy toll for their underestimation by printing more money to finance government deficit. We can draw empirical evidence from the past to prove this basic Economics principle which I will talk about in the next topic, hopefully. For now I hope we could understand the reasons why printing more money is not the right path to prosperity. Thanks to my extreme expansionary monetary policy, I am no longer hired as the Chief Economist of Richland. I hope to see you soon in Part 2 of this discussion.
