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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)

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10 Answers

up vote 21 down vote accepted

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.

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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. 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 3 '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. –  Ganesh Sittampalam 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 3 '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. –  Ganesh Sittampalam May 3 '11 at 12:11
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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”.

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Interesting. Too bad I can't access the full paper. Perhaps I will visit a library, they often have JSTOR access. –  Stainsor May 3 '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.

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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. –  fennec 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 3 '11 at 11:08
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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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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).

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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.

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You did not directly answer my primary question (in the title). –  ripper234 Apr 9 '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 9 '10 at 13:44
    
Not loan, borrow. Mostly by issuing treasury bonds. And they do it by the trillion. –  Sylver May 3 '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?

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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. –  Ganesh Sittampalam May 3 '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 3 '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 3 '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 3 '11 at 14:45
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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 3 '11 at 17:05
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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.

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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.

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