Explain the meaning and implications of the government “ printing” money.
The main question here is; can a government print money effortlessly. It is true that a government can print money to finance its activities, however, too much printing of money comes with consequences. There are two ways in which a government can print money, namely through the printing of banknotes and coins and secondly through forcing the central bank to buy government bonds. 1st let’s explain the printing of banknotes and coins process.
The only institution that has the sole responsibility to print the notes and coins in South Africa is the SARB, therefore the government itself does not print money. Upon printing of notes and coins say of R1OM value, it will not become or counted as money yet, because only cash and deposit held by the private non-bank sector are counted as money.
The next step in explaining this is, when the money is printed, SARB will sell the notes and coins to banks and subtract its costs of printing, say R0.1M, and make a profit of R9.9M which accrues to the government, and is then paid to the government, and thus increase the government deposit. But remember government deposits are not counted as money.
The R10M received by the banks will not increase the money supply because they will be used to replace old and torn old notes and coins.
Money supply will increase when the government introduces the R9,9M into circulation through payments to the private sectors, like payments to contractors. An R5M payment to the contractor will increase the money supply by R5M. The government has the advantage of printing new money, however, without enough discipline, this is the most dangerous activity to engage in. Corruptible and misuse of the printing facilities will lead to excessive printing of money that will lead to hyperinflation.
Explanation of the other form of government printing of new money is when the government forces the reserve bank to purchase government securities. This leads to excessive borrowing from the central bank by the government. Continuous issues of government bonds will gradually lead to multiple increases in the money supply. This process of forcing the central bank to buy government securities is sometimes called monetization of government debt. Two good examples where both the printing of money and monetization of government were used are Zimbabwe and Germany.
Forcing the central bank to purchase government securities is effective when the central bank lacks independence. The effects of monetization of government debt are predictable, using the quantity of money theory Which states that MV=PY, where V & Y are constant, an increase in M will lead to an increase in P. Therefore, as the government sell securities to the central bank and spending the proceeds by depositing the funds in the non-banking private sector, the M component increases, and as a result, the P component also increases. M represents money supply while P represents the price level. Thus there is a positive relationship between M & P.
Repetition of this process will lead to hyperinflation in the medium and long term, the reason being that monetization of government debt leads to a vicious circle of money creation which leads to inflation, and the inflation which will call for further creation of more money through selling of government securities to the central bank. As a result, the government will depend on this process to fund its expenditure.
