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This question is raised in the movie Money as Debt (at time index 29:00).

The answer that immediately pops to my head is "because printing money causes inflation".

However, according to this movie, money is created not only by printing it but rather more so by borrowing it (watch the movie for the details). In that case, borrowing money from banks also creates money - can't this this cause inflation as well? In this case, my question is the question the movie raises:

Why do governments borrow money instead of printing it? (When printing money, one doesn't need to pay interest).

(Note - I am asking an objective question, regardless of how objective the movie might or might not be)

ripper234
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10 Answers10

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Governments borrowing money doesn't create new money. When banks "borrow" money (i.e. take deposits), it does effectively create money because the depositor expects to be able to get the money back at any time, but the bank assumes that most won't actually do this and lends out most of the money to other people. If everyone did actually ask for their money back at once, the illusion of the extra money created by this process would collapse, and the bank would go bust.

In contrast when governments borrow money, the loan isn't repayable on demand, it has a fixed maturity and the money is only repaid at the end of that period (plus interest at defined points during the period). So holders of government debt don't have money they can spend (they can turn it into money they can spend but only by finding someone else to buy it).

So government debt doesn't create inflation in itself. If they printed money, then they'd be devaluing the money of everyone who had saved or invested, whereas if they borrow money and use taxes to repay it, the burden falls more evenly across the economy and doesn't disproportionately penalise certain sets of people.

GS - Apologise to Monica
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    I like this answer. I'll expand a little by mentioning "Quantative Easing" which is the modern way for governments to print money. They then spend the new cash on buying up their own bonds. The UK government has used this to devalue the pound and so improve export competitiveness.

    http://en.wikipedia.org/wiki/Quantitative_easing

     – Turukawa Aug 29 '10 at 11:22
  • @Ganesh: very interesting, so can we say that the bank system is basically generating always inflation? – Marco Demaio Dec 03 '10 at 19:36
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    @Marco: not really, it's much more complicated than that. Look up "money supply" on wikipedia for example. For one thing, if bank deposits stay flat then no new money is being created. – GS - Apologise to Monica Dec 11 '10 at 17:45
  • @Ganesh: And where exactly does the money that the government borrows come from? What do you think happens when the federal reserve buys $XX billion in treasury bonds? From Dec. 2008 to March 2010, the Fed bought $1.75 trillion in bonds. Where does that money come from? When the government borrows money and spends it, the total volume of money in circulation augments, thereby trigerring inflation. – Sylver May 03 '11 at 11:04
  • The federal reserve buying bonds like that is quantitative easing, as Turukawa also mentioned. That does indeed increase the money supply. But it's not normal practice, either in the past before the financial crisis or (they claim) for the future. – GS - Apologise to Monica May 03 '11 at 12:11
  • @Ganesh: Quantitative easing is a fancy term for pumping currency into the economy. The US gvt. revenue for 2010 is estimated at $2.38tn. The Fed created $1.75tn to purchase treasuries. This is not insignificant. While most monetary creation occurs at banks' level, it is incorrect to say that government borrowings do not increase the volume of money on the market. It can and it does. – Sylver May 03 '11 at 14:04
  • I'm just saying that it's the quantitative easing that is creating the new money, not the borrowing itself. – GS - Apologise to Monica May 03 '11 at 15:59
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    How about foreign debt? It does increase domestic money supply, doesn't it? – Fitri Feb 21 '12 at 16:38
  • all borrowing creates new money –  Jun 02 '13 at 04:42
  • No more than borrowing horses creates new horses. – GS - Apologise to Monica Jun 02 '13 at 21:08
  • @user9302 only borrowing which is not full-reserve. – Gregory Magarshak Apr 14 '17 at 20:04
  • I'd like to clarify something. You state that government borrowing does not create new money, but that the borrowing is balanced by taxation. Taxation by definition destroys money, therefore, if the money supply is not to be affected, the government borrowing MUST be creating money.

    Or am I misunderstanding?

     – Benjamin Chambers Jul 12 '17 at 20:58
  • @BenjaminChambers in what way does taxation destroy money? It's just a transfer from someone/something to the government. And borrowing is only balanced by taxation over the long-term, in the short-term the government might be running a deficit or a surplus. – GS - Apologise to Monica Jul 12 '17 at 21:17
  • By definition, a currency issuer spending money creates that money and a currency issuer receiving funds destroys that money. It's not like they keep a checking account at Chase (well they do, but for a different purpose). – Benjamin Chambers Jul 12 '17 at 21:22
  • @BenjaminChambers the central bank creates the money, not the government. – GS - Apologise to Monica Jul 13 '17 at 06:19
  • Now you're getting into semantics. The currency issuer creates the money by putting it out there and destroys money by receiving it. When the central bank is a governmental entity, then the government creates money by spending and destroys money by taxing. When governments are not currency issuers (countries within the EU or states within the US) then they do not create and destroy funds in this way. – Benjamin Chambers Jul 13 '17 at 17:21
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    @BenjaminChambers this is veering rather off-topic. Now that the economics stackexchange exists, perhaps you could ask a fresh question there. – GS - Apologise to Monica Jul 13 '17 at 21:59
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“Why do governments borrow money instead of printing it? (When printing money, one doesn't need to pay interest).” Good question. Numerous leading economists, including a couple of economics Nobel Laureates have asked the same question and concluded that borrowing can be dispensed with.

First, Milton Freidman set out a monetary system in a paper in the American Economic Review which involved no government borrowing, and govt just printed money (in a responsible fashion of course) as and when needed. See: http://www.jstor.org/pss/1810624

A second Nobel Laureate with similar views was William Vickrey.

A third economist with similar views (of Keynes’ era) was Abba Lerner. Keynes said of Lerner, “Lerner's argument is impeccable, but heaven help anyone who tries to put it across to the plain man at this stage of the evolution of our ideas”.

  • Interesting. Too bad I can't access the full paper. Perhaps I will visit a library, they often have JSTOR access. – Stainsor May 03 '11 at 12:24
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Yes - Simply put, printing money is called "monetizing the debt" and would result in some nasty inflation. It's a no-no as it quickly devalues the currency and makes it far more difficult to borrow in the future, an entire generation will remember getting burned by it. If, say, Canada's currency were suddenly worth half as much and you received half your investment back in US dollars (e.g. you paid US$10,000, but now have US$5000) would you ever trust them again?

The economy is far more complex than one can discuss here, but the fractional reserve system is the next creator of money, although it's not unlimited, the reserve requirement throttles it back. The demand for loans is impacted both by the rate itself and the bank's willingness to lend.

The housing bubble had multiple causes. In a sense Tucson is right. Anything we do to make houses more affordable can cause house price inflation. But - the over the top underwriting had more impact in my opinion. People lost sight of good lending practices. The option rate interest only ARMs were financial time bombs.

JTP - Apologise to Monica
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  • Yeah; if you do enough inflation - a lot like stealing money from people who have it already - people will wise up to it, and start anticipating inflation, and not want to take your money. And then you end up like Zimbabwe, with 10-trillion dollar notes that are worth $5 today and a nickel next week. –  Apr 16 '10 at 18:01
  • The problem is that borrowing money also triggers monetary creation and thus inflation. When 50% of treasury bonds are bought by the federal reserve, what do you think happens next? – Sylver May 03 '11 at 11:08
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One important answer is still missing: governments may not be able to do print money because of international agreements. This is in fact a very important reason: it applies to the entire Eurozone.

(I admit that many Eurozone countries also not allowed to borrow as much as they do now, but somehow that's considered a far lesser sin).

MSalters
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If the government prints money recklessly and causes inflation, people will come to expect inflation, and the value of the currency will plummet, and you'll end up like Zimbabwe where a trillion dollars won't buy a loaf of bread.

If the government actually pays people for the money they borrow, they don't have this problem - and as it turns out, the US government can get pretty good rates on borrowing in general, in part because they're extraordinarily good about paying them back. (Also, inflation expectations are low, so people will accept 1-2% interest rates. If you expected inflation of 10%, you'd see people demanding something more like 12% interest rates.)

(The downside of too much of this sort of borrowing is that it "crowds out" other borrowing, which may harm the economy. Who would lend money to / invest in a small business, if the government is paying good money and there's almost no risk at all?)

Now, inflation can come into play afterward, if the Fed decides it needs to maintain "easy money" policies to stimulate the economy (because taxes are too high because we're paying off the debt, or because we've crowded out smaller borrowers, or something).

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In general, you can count on the the principle that if you, as the government, try to play too many games with people's money... well, people aren't stupid; they will eventually catch on, and adjust their behavior to compensate, and then you're right back where you started, but with less trust.

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The government could actually do either one to expand the money supply as necessary to keep up with rising productivity / an increased labor supply. The question is merely political.

In the case of the US, printing money involves convincing politicians to spend it. While we currently run a deficit, there is a large lobby within the US who are incredibly anti-deficit, and are fighting against this for no good reason. If the money supply were left in their hands, we would end up with a shrinking money supply and rapid deflation.

On the other hand, the Fed can simply bypass the politicians, and control the money supply directly by issuing bonds. It's easier for them, they don't have to explain it to voters (only to economists), and it gives them more direct control without any messy political considerations like which programs to expand or cut.

Benjamin Chambers
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The Government doesn't borrow money. It in fact simply prints it. The bond market is used for an advanced way of controlling the demand for this printed money. Think about it logically. Take 2011 for example.

The Govt spent $1.7 trillion more than it took in. This is real money that get's credited in to people's bank accounts to purchase real goods and services. Now who purchases the majority of treasuries? The Primary Dealers. What are the Primary Dealers? They are banks. Where do banks get their money? From us.

So now put two and two together. When the Govt spends $1.7 trillion and credits our bank accounts, the banking system has $1.7 trillion more. Then that money flows in to pension funds, gets spent in to corporation who then send that money to China for cheap products... and eventually the money spent purchases up Govt securities for investments. We had to physically give China 1 trillion dollars for them to be able to purchase 1 trillion dollars in securities. So it makes sense if you think about how the math works in the real world.

Paul
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I believe there are two ways new money is created:

  • Central bank (the "Fed" in the US) "printing" new money (they press a button, literally get new money, and buy US Government Treasuries from banks)
  • Commercial Banks making new loans (because of the fractional reserve banking)

My favorite description of this (money creation) comes from Chris Martenson: the video is here on Youtube.

And yes, I believe both can create inflation. In fact this is what happened in the US between 2004 and 2007: increasing loans to households to buy houses created an inflation of home prices.

tucson
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    You did not directly answer my primary question (in the title). – ripper234 Apr 09 '10 at 13:34
  • ah yes... the question... :) Well, I don't think governments loan much money. And if they do, I don't believe that creates new money. I am not sure... – tucson Apr 09 '10 at 13:44
  • Not loan, borrow. Mostly by issuing treasury bonds. And they do it by the trillion. – Sylver May 03 '11 at 11:10
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My own simple answer is that it will affect and reduce productivity (e.g. Zimbabwe). it will also cause inflation which mean that no one will want to work for production again.

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My answer is that when confronted with the obvious, the most common human reaction is to seek reasons for it, because things have to be right. They have to have a reason. We don't like it when things suck.

So when finding out that you are being ripped off every day of your life, your reaction is "There must be a logical reason that perfectly explain why this is. After all, the world is fair, governments are working in our best interest and if they do it this way, they must have a very good reason for it."

Sorry, but that not the case. You have the facts. You are just not looking at them.

Economics, as a subject, is the proper management of resources and production. Now, forget the fancy theories, the elaborate nonsense about stocks and bonds and currencies and pay attention to the actual situation.

On our planet, most people earn $2,000 per year. Clean water is not available for a very sizable percent of the world's population. Admittedly, 90% of the world's wealth is concentrated in the hands of the most wealthy 10%. A Chinese engineer earns a fraction of what a similarly qualified engineer earns in the States. Most people, even in rich countries, have a negative net value. They have mortgages that run for a third of their lifetimes, credit card debts, loans... do the balance. Most people are broke.

Does this strike you as the logical result of a fair and balanced economic system?

Does this look like a random happenstance?

The dominant theory is "It just happened, it's nobody's fault and nobody designed it that way and to think otherwise is very bad because it makes you a conspiracy theorist, and conspiracy theorists are nuts. You are not nuts are you?"

Look at the facts already in your possession. It didn't just happen.

The system is rigged. When a suit typing a few numbers in a computer can make more money in 5 minutes than an average Joe can make in 100 lifetimes of honest, productive work, you don't have a fair economic system, you have a scam machine.

When you look at a system as broken as the one we have, you shouldn't be asking yourself "what makes this system right?" What you should be asking yourself is more along the lines of "Why is it broken? Who benefits? Why did congress turn its monetary policy over to the Federal reserve (a group of unelected and unaccountable individuals with strong ties in the banking industry) and does not even bother to conduct audits to know how your money is actually managed?

This brilliant movie, Money as debt, points to a number of outrageous bugs in our economic system. Now, you can dream up reasons why the system should be the way it is and why it is an acceptable system. Or you can look at the fact and realize that there is NO JUSTIFICATION for an economic system that perform as badly as it does.

Back to basics. Money is supposed to represent production. It's in every basic textbook on the subject of economics. So, what should money creation be based on? Debt? No. Gold? No. Randomly printed by the government when they feel like it? No (although this could actually be better than the 2 previous suggestions)

Money is supposed to represent production. Index money on production and you have a sound system. Why isn't it done that way? Why do you think that is?

Sylver
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  • Directly indexing money on production would be circular, because money is also needed to determine the relative value of different goods and thus the value of the production as a whole - i.e. there'll always be some lag in determining what the money supply should be based on production. Most countries operate an inflation target which does seek to close this feedback loop and keep money in line with production, albeit with a built-in offset rate. The problem with making that target 0% is that then whenever you undershoot you'll have deflation which has its own problems. – GS - Apologise to Monica May 03 '11 at 12:21
  • @Ganesh: Indexing money on production is not necessarily circular. Create a basket of key products (not unlike the basket of products used to calculate inflation). Using production trends, determine projected production for the period and assign a $ value. That's your basis for the money supply. Manage it over time to keep the money supply on par with production. It can be done. Our current money supply is utterly disconnected from production fundamentals. Simple example: Do you think the US produces 3 times as much as China? No. Yet the US GDP is nearly 3 times that of China... – Sylver May 03 '11 at 14:20
  • ...The basis of monetary creation in our current society is debt. Debt is NOT correlated to production, and interest ensure that there can never be enough money on the market to cover the total debts. "Most countries operate an inflation target which does seek to close this feedback loop and keep money in line with production" is incorrect. It might be what is advertised, but it does not match the realities which we have to live with. In – Sylver May 03 '11 at 14:28
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    PS: about deflation. You hear about it, but don't expect to see it any time soon. For deflation to actually occur, the volume of production should increase faster than the volume of money (per definition). That doesn't happen when money is created by the bucketload, and when it is contrary to the best interests of the powers that be. (deflation = lower prices/salaries => lower tax brackets => higher purchasing power) Unless you are living on borrowed money, deflation is something you should welcome... but it's not gonna happen if we keep printing money like mad. – Sylver May 03 '11 at 14:45
  • I do think the US produces 3 times as much as China, if that's what the GDP differential is, modulo any artificial manipulation of the exchange rate by the Chinese. Certainly I think it produces substantially more than China does. – GS - Apologise to Monica May 03 '11 at 16:06
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    @Ganesh: What does the US produce, these days? You really haven't looked where your stuff come from, have you? – Sylver May 03 '11 at 17:05
  • Computer software, oil/natural gas, healthcare, food, planes, ... – GS - Apologise to Monica May 03 '11 at 23:31
  • You claim that what I say about the inflation target is incorrect, but the published statistics show that the target is broadly met, at least over a period of many years. Are you claiming that the inflation figures are faked, or something else? – GS - Apologise to Monica May 03 '11 at 23:33
  • @Ganesh: Healthcare is the only sector which still has growth in the US. The rest has been on the downslide. The US has been operating on a trade deficit for the last 40 years (i.e. producing less than home consumption). FYI, >30% of Boeing airplane parts come from China. Software? Big US companies have been setting shop overseas for years. You will find a similar situation across industries. The US was a producing country 40 years ago. Now it's a country focused on consumption and import. The US certainly does not produce 3x the Chinese production. – Sylver May 04 '11 at 03:33
  • "Are you claiming that the inflation figures are faked, or something else?" Read my comment again. Current inflation targets are disconnected from the actual production. Further, the effect of cumulative inflation targets is not understood by most: an innocent 2% inflation target means a 4.4x increase in prices over a lifetime. 3%? 9.2x. 4%? 18.9x. My father started working as a well paid chemical engineer for an oil company. About 40 years ago. His salary? 800 "old" FF (== "new" FF80 == €15)/month. Good money. Today, €15/hour is lame. Is inflation really under control? – Sylver May 04 '11 at 04:03
  • I think you're confusing rate of change with absolute values. Also, the US trade deficit, while large, is less than 5% of total GDP (and the GDP figures measure production, not consumption.) – GS - Apologise to Monica May 04 '11 at 04:42
  • Why would you think that? US trade deficit... it's a deficit and has been so for over 40 years, in spite of the fact that the USD is bolstered by its status as a reserve currency. Re: GDP, where did I say GDP referred to consumption? Don't resort to a strawman argument. It's not constructive in the least. – Sylver May 04 '11 at 05:08
  • I wasn't trying to put words in your mouth, I was just making it clear what the 5% was based on. See the table 3 of http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp1q11_adv.pdf for the figures. – GS - Apologise to Monica May 04 '11 at 06:49
  • I think you're confusing rate of change with absolute values because I gave a list of the things that the US produces, and you started talking about whether the production of those things was growing or shrinking. Even if they were shrinking, that doesn't preclude the absolute value being large. – GS - Apologise to Monica May 04 '11 at 06:51
  • @Ganesh, Ok, I see what you meant. In absolute terms, the US still produces a lot, but no where near as much as China, and certainly not 3x. When production goes down for half a century, you can't expect to still keep the top spot. – Sylver May 04 '11 at 09:51
  • So what part of the GDP figures (a quick google says that China has a GDP of $5tn compared to the US GDP from those figures of $14tn) do you claim are wrong? Are you claiming that the yuan is undervalued by a factor of more than 3? Most references I can find suggest the fair value is more like 50% difference. – GS - Apologise to Monica May 04 '11 at 10:12
  • If you look at it by purchasing power parity, the US still produces roughly 50% more than China: http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP) – GS - Apologise to Monica May 04 '11 at 10:21
  • @Ganesh: I would object that GDP adjusted for PPP is still not a proper measure for production, but even without getting into this, you are making my point: According to this, the US produces 1.5x as much as China, and earns 2.5x more, which would be impossible if money was directly linked to production. Money SHOULD be representative of production, but this IS NOT the case. And when arbitrary targets for inflation are picked (and met through accounting tricks), these target don't automatically reflect the production, adding stress on the economic system. – Sylver May 04 '11 at 14:28
  • The end result will be depend on the basket of goods chosen - the Wikipedia article on PPP has some discussion of this. If you chose a basket more biased towards what is consumed in the USA rather than China, you would likely get a higher ratio. Also, the Chinese are deliberately selling their output cheap, so while the yuan is linked to Chinese production and the dollar is linked to US production, the exchange rate between the two is not what it would be naturally. – GS - Apologise to Monica May 04 '11 at 14:59
  • No matter whose fault it is, it demonstrates that money doesn't reflect production in this system. QED. But anyway, I got it. It's China's fault, the system works, and if there are huge inequalities in wealth between the top 5% and everybody else, it just happened, because our system is just fine and fair and everything is as it should be in this best possible of economic systems. Wake up! It's broken. It's not working as it should and the consequences are brutal, especially if you live anywhere outside of the top 10 richest countries. And even there most people producing wealth are broke. – Sylver May 04 '11 at 16:33
  • Now who's setting up a strawman? – GS - Apologise to Monica May 04 '11 at 17:02