Three meanings of "printing money causes inflation"

This is supposed to be a very simple post, mainly for non-economists.

"Printing money causes inflation" can mean three different things. What I will say here should be obvious to economists, but I'm not sure if it is obvious to non-economists. And it makes me wonder if sometimes things get lost in translation. Maybe, just maybe, some people are strongly opposed to central banks printing very large amounts of money because they misunderstand "printing money causes inflation". Who knows? Tell me what you think.

Those of us who teach Intro Economics know we have to spend some time carefully explaining the "other things equal" clause, and why it matters. Because the students won't get it unless we explain it. We tend to take it for granted that the silent "other things equal" clause is understood, but it might not be understood by all.

Here are three meanings of "Printing money causes inflation":

1. If the central bank prints money, so the stock of money grows at above 0%, that will cause the inflation rate to be above 0%. (And if it prints a lot of money, so the stock of money grows a lot above 0%, that will cause the inflation rate to be a lot above 0%.) Relative to 0%.

2. If the central bank prints money faster than it did in the past, that will cause the inflation rate to be higher than it was in the past. Relative to the past.

3. If the central bank prints money faster than it would otherwise have done, that will cause the inflation rate to be higher than it would otherwise have been. Relative to the counterfactual conditional.

When I say "printing money causes inflation" I always mean it in that third sense.

I don't mean it in the first sense. Because it would be false. For example, if an economy was growing very steadily and evenly at 3% per year (say from 3% population growth), the central bank would need to print money to keep the stock of money growing at 3% per year too, just to keep inflation at 0%.

I don't mean it in the second sense either. Because that would be false too. Because lots of things fluctuate from year to year, causing the demand for money to fluctuate from year to year, and the central bank would need to make the stock of money fluctuate too, to offset those other fluctuations, just to keep inflation constant from year to year.

I mean it in the third sense.

Since the Great Recession began, many central banks have been printing a very large amount of money. Did that printing money cause inflation?

Yes, I believe it did. In that third sense. I believe that printing very large amounts of money caused inflation to be higher than it otherwise would have been. But in many countries, (e.g. the US) all that means is that inflation fell less than it otherwise would have done.

Those central banks that printed large amounts of money didn't do so on a whim. They didn't print money when other things were equal. They printed large amounts of money precisely because other things were not equal. They feared that if they did not print large amounts of money, then inflation would have fallen, or even gone negative (deflation).

(I cannot prove that my belief is true. Because I do not observe what would have happened otherwise. I do not observe the counterfactual conditional. We never do. We are stuck in the actual world, and can't observe all the other possible worlds. And all sciences, not just economics, face that same problem. But I do have some reasons for believing it nevertheless. First, because history does give us what look like natural experiments, where other things probably were roughly equal. Second, because central banks that decide to target inflation seem to be able to roughly hit their target. But that is not the point of this post.)

But those special circumstances, that caused central banks to print very large amounts of money to prevent inflation falling, won't last forever. Do I fear that the very large amounts of money that they have been printing will cause inflation to explode when those special circumstances revert to normal?

No. I don't fear that there's a pent-up inflationary pressure from all that money printing that is just waiting to explode when things return to normal. Because I believe that central bankers aren't stupid. If, or rather when, it starts to happen, they will put the money printing into reverse, to prevent it happening. Central banks will buy back the extra money they previously printed, to prevent inflation rising too much. But if, for some unknown reason, they couldn't or didn't buy back that extra money, then yes, I do believe that there would eventually be a very big increase in future inflation from the very large amounts of money that have been printed.

(But that, paradoxically, explains why they needed to print so very large amounts of money to prevent inflation falling more than it did. Because a temporary increase in the supply of money has a much smaller effect on inflation than an increase that is expected to be permanent. Because today's inflation depends on expected future inflation, as well as on the stock of money today.)

Comments

[Ron Waller]

I think an important element to the money printing debate is that the amount of money a central bank can print — called "state money" — makes up only a small percentage of the total money supply. When the Fed tripled the state money supply through Quantitative Easing, it only made up 15% of the total money supply.

According to an article from the FP, Money. Where's the money?, the US money supply actually fell below trend (unlike in Germany and Canada) while the Fed was printing money through QE.

Most of the money supply is created when banks issue loans. So to limit the growth of the total money supply (and to reduce inflation), the central bank can raise base interest rates, or increase reserve requirements. Of course, Friedman's idea there's a direct link between the money supply and inflation has been discredited. (According to Krugman, Friedman's monetarism is effectively a simplistic version of the Hicksian IS-LM model Keynesians use.)

So the idea QE will lead to runaway inflation is predicated on a complete ignorance of the basics of how the monetary system works. This means the people making the runaway-inflation argument are either very foolish or very dishonest (have an ulterior motive.)

[Nick Rowe]

Ron: I tend to agree partly. (But it depends on what you mean by "direct link"). From the perspective of this post, I would look at the amount of money created by commercial banks as one of those things in the "other things equal" clause, and that the central bank needs to offset when they change over time and aren't equal in the real world. (And Friedman himself paid a lot of attention to commercial bank money.)

[Lorenzo from Oz]

This should be the standard post for folk to link to whether "printing money inflation" comes up, thank you for the public service. :)

[Lorenzo from Oz]

Ron Waller: the irony is that Friedman's mistake was not to take his expectations critique of the Philips Curve as an instrument of policy far enough.
http://skepticlawyer.com.au/2013/04/15/check-your-expectations-3-milton-friedman-not-going-far-enough/

[Market Fiscalist]

Great post.

And for once I think I both understand it and agree with it on first reading - which (I hope) means I may have started to make the transition from non-economists to economist after 3 years of reading (and studying!) this blog.

[Sandwichman]

Other things being equal, Nick, there's been a raging debate in philosophy of science over the past couple of decades regarding the legitimacy of "CP-laws" -- that is to say "laws" hedged in by a ceteris paribus clause. The other things equal clause may be headed in the same direction as Santa Claus, something we let children believe in that we know doesn't exist. Anyway, there's a hilarious exchange in the 19th century between William Thornton and John Cairnes where Thornton respectively denounce and uphold and uphold and denounce "opposite" principles that are in fact simply a restatement of the same principle. The secret to the debacle is the kakeidoscopic versatility of their respective ceteris paribus clauses. See my post, "Ceteris paribus, Dr. Jekyll tans his own Hyde":

http://ecologicalheadstand.blogspot.com/2014/09/ceteris-paribus-dr-jekyll-tans-his-own.html

[Sandwichman]

Should have been "Thornton and Cairnes respectively denounce and uphold and uphold and denounce..."

[Wong Hw]

Nick says "No. I don't fear that there's a pent-up inflationary pressure from all that money printing that is just waiting to explode when things return to normal. Because I believe that central bankers aren't stupid. If, or rather when, it starts to happen, they will put the money printing into reverse, to prevent it happening. Central banks will buy back the extra money they previously printed, to prevent inflation rising too much."

I don' understand this. If CBs start to buy back the extra money, what would they use? More money? Would that not increase more money into the banking system?

[Mike Sproul]

Wong:

The central bank would normally buy back the extra money with its BONDS. The central bank issued that extra money in exchange for bonds in the first place, so it's clear that the central bank can reverse the process and retire that extra money in exchange for bonds.

Or the central bank might have issued the money on loan, in which case the extra money can be retired as loans are repaid to the central bank. Or maybe the money was issued by the government itself, just printing it and spending it building roads. In that case, the government could retire the money by collecting it as taxes and burning the money as it comes in.

[Ralph Musgrave]

Nick,

Most MMTers (of which I’m one) will object to your article on the grounds that you haven’t distinguished between where the state prints money and SPENDS IT in the usual public sector stuff (education, roads, etc) and in contrast, where the state prints money and BUYS ASSETS held by the private sector, especially government debt (i.e. QE).

In the first case, what MMTers call “private sector net financial assets” rise. In the second case they don’t. Thus the inflationary effect of the first is much larger than the second. I suspect you’re assuming the first.

MMTers (far as I can see) believe in implementing stimulus via the first – as do various other groups, e.g. Positive Money. Milton Friedman also advocated the first (see link below). And Market Monetarists, far as I can see, advocate the second, which I don’t agree with basically, though it's a supplementary fine tuning tool which isn't totally useless.

http://0055d26.netsolhost.com/friedman/pdfs/aea/AEA-AER.06.01.1948.pdf

[Wong Hw]

Mike: "The central bank would normally buy back the extra money with its BONDS". Sorry Mike, I'm still confused.

When government sells Treasuries, it reduces the money base and the private sector holds less cash. But if the the government redeems its own BONDS, the money base will expand as it has to return cash to the buyer. So I am not sure what BONDS are use to "buy back the extra money". Are new Treasuries being issued or is government selling off commericial bonds to the corporate issuer to take back cash and thus reduces the money base?

[Nick Rowe]

MF: Thanks! And it is your opinion, as a non-economist who has been following and learning from the economics blogs debate, that really matters for this question.

Thinking of your own experience, do you think it is plausible that some (many?) people are really scared of and opposed to printing money because they interpret "printing money causes inflation" in that first or second sense?

[Nick Rowe]

Sandwichman: When medics do a test of a new drug, they get 100 people and toss a coin to decide who gets the new drug and who gets a placebo. And they toss a coin because they know that other things matter too, but they aren't at all sure what those other things are. All they know (or all they think they know) is that the toss of the coin itself is not one of those other things, and will be uncorrelated with those other things.

And people who drive cars know that pressing down the gas pedal causes the car to go faster, other things equal, but they don't always know what all of those other things are. (And the cruise control doesn't know whether the car is going uphill or into a headwind or on a gravel road.) But they can still use that knowledge about the effect of gas pedal on speed to drive at roughly the speed limit. Just like the Bank of Canada can use its knowledge to keep inflation at roughly 2%.

[Nick Rowe]

Wong: this is the easiest way to think about it: keep the Bank of Canada separate from the rest of the government. The Bank of Canada can print or burn money, and can buy and sell bonds for money, and so alter the mix of bonds and money that people hold. The rest of the government cannot print or burn money, but it can print or burn bonds. It can borrow money from people by selling bonds, and then immediately spend that money, so people hold the same amount of money but more bonds. Or it can tax people, and use the money it collects in taxes to redeem (buy back) bonds, so people hold the same amount of money but fewer bonds.

[Nick Rowe]

Ralph: yep. MMTers will disagree with this post, because they think it is printing money+bonds that causes inflation. But that is not what this post is about, and we could give exactly the same 3 meanings to "printing money+bonds causes inflation".

[Nick Rowe]

Actually, Wong's comments are really interesting to this post. Because Wong seems to me to be an intelligent guy, but one who doesn't know much macro. There must be loads of people like Wong out there.

And if I understand him correctly, Wong believes that printing money is a one-way street: you can easily increase the money supply by printing money, but it is very hard to put that into reverse and reduce the money supply again.

Suppose that I believed what (I think) Wong believes. I would be scared shitless of inflation, and I would be very opposed to the amount of money that central banks had been printing, and would be yelling at them to stop.

Is that a plausible theory of why *some* (how many??) people are in favour of a tighter monetary policy??

[Lorenzo from Oz]

There is something counter-intuitive about "they will just get rid of the money". Once you explain the mechanics, it is fine, but how many people ever have said mechanics explained to them?

[Nick Rowe]

Lorenzo: Exactly!

I think this requires a short post.

[Sandwichman]

Nick,

Yes, I'm glad you brought that up. I know about drug testing. My housemate is an Assistant Professor in the Department of Anesthesiology, Pharmacology & Therapeutics at UBC.They use double-blind experiments with a control group to test drugs. They don't use the term ceteris paribus in some thought experiment from which they generalize. Designing a drug test is very complicated and there is a lot of controversy about whether a particular result was valid, centering around the composition of control groups

I'm also glad you mentioned driving cars. Nancy Cartwright uses the analogy of a "nomological machine" to probe the constraints that have to exist for ceteris paribus laws to not be vacuous. Because they originate from these nomological machines:

"C-P laws are both local and fragile: they hold just where and when the relevant machine is working correctly. The successful identification and use of such laws cannot be achieved by uncontextual general principles alone, but requires messy contextual knowledge..."

So, yes, a case can be made for the local and contextualized use of ceteris paribus. That doesn't make it appropriate for generalized all-purpose application.

[Sandwichman]

"Just like the Bank of Canada can use its knowledge to keep inflation at roughly 2%."

You may be right there. Isn't that scary? Presumably the purpose of a central bank is broader than merely "keeping the inflation rate at 2%." Can a bank keep inflation at roughly 2% while, say, maintaining full employment? Are general laws using ceteris paribus clauses the main tool they use to do this? There is also the prospect of tailoring (pun intended) the goal to the tools at hand. Other things being equal, every problem is a nail when the tool you know how to use is a hammer.

[Nick Rowe]

If the only tool the Bank of Canada has is a hammer, and if it can only hit one nail, so the only choice is what nail to hit (2% inflation? 5% NGDP? The exchange rate? etc.) that is a sensible way of looking at the world.

If doctors and driving instructors are allowed to say "other things equal", I don't see why economists shouldn't be allowed to.

Yes, the effect of technology shocks on the economy will depend on whether the central bank is targeting inflation or NGDP. Just like the effect of hills on speed will depend on whether the driver is holding the gas pedal constant or targeting the speed limit.

[Left Coast Bernard]

Dr Rowe,

For us amateurs, don't you think that you should probably also mention that "printing money", as economists use the term, doesn't actually mean printing money?

Indeed most "printing" of money involves a Bank of Canada or Federal Reserve Bank person typing, tap, tap, tap, on her computer keyboard, or something similar at a bank. All she does is change some numbers stored on a computer somewhere.

[Nick Rowe]

LCB: what you say is generally exactly right. And the principle is exactly the same whether we are talking about paper (OK Canadian notes are now plastic) money that literally is printed, or electronic money that is created with a computer keyboard.

But for the Bank of Canada, because Canadian commercial banks usually hold very small reserves on the Bank of Canada's computer, and unlike the Fed, most of the money really is paper (OK plastic) notes.

[Market Fiscalist]

'do you think it is plausible that some (many?) people are really scared of and opposed to printing money because they interpret "printing money causes inflation" in that first or second sense?'

I do agree that most people tend to think "inflation makes things more expensive so I will be poorer". They assume that "others things are equal" all the time (they would not have strong concept of the demand for money) and as most people are aware we do have non-zero inflation in normal times I think they would go for 2. I think a lot of conservatives (who have no economic training) instinctively think of stimulus as "printing money to pay for stuff that will benefit other people" - they don't get monetary policy at all and think of new money as either being spent into existence or just given away. And they're against it.

[Philippe]

Rain dances cause more rain to fall than would otherwise have fallen.

[Nick Rowe]

Philippe: The Bank of Canada has hit a pre-announced 2% inflation target over the last 20 years. They were told to hit that target, and they hit it. All by adjusting the quantity of rain dances. Amazing coincidence.

MF: Thanks. The sort of comment I was looking for.

[Philippe]

My rain dances cause roughly the same amount of rain each year, except on those occasional years where there is a drought or a flood. On those occasions, my rain dances still cause more rain to fall than would otherwise have fallen.

[Sandwichman]

Nick: "If doctors and driving instructors are allowed to say "other things equal", I don't see why economists shouldn't be allowed to."

James Woodward has argued ("There is no such thing as a ceteris paribus law" 2002) that ONLY economists make regular and explicit use of the ceteris paribus term. Of course everybody makes "other things equal" assumptions. If it isn't cloudy today, it will by sunny. The question is really about relying on them and on general laws derived exclusively from the use of them. Remember the Phillips Curve? I bring that up partly to show that this isn't off topic but also because Woodward specifically addressed the Phillips curve and the Lucas critique with respect to ceteris paribus clauses in "Explanation and Invariance in the Special Sciences"(2000). Whatever one may think of the Lucas critique, one can be confident that the Bank of Canada will not be using a Phillips curve to decide how much money to print. The "laws" underlying the Phillips curve are not invariant under the relevant conditions given changes in the information and expectations of individual agents.

[Sandwichman]

I should say the question is really about relying on them and on general laws derived exclusively from the use of them in situations where direct observation of the important confounding variables is difficult or impossible. In other words, ceteris paribus + abstraction = whatever you want it to. As for the Lucas critique, it just displaces this formula to the microlevel of an unreal rational agent where people can get tied up in knots arguing about the unreality of the assumption. Unreality is not the main problem. The problem is the fundamental instability of the assumption. It's a Humpty-Dumpty word.

[Nick Rowe]

Philippe: But if the average rainfall had previously been 40" (4%), and I told you to cut it to 20" (2%) for the next 20 years, could you deliver? Because the Bank of Canada did deliver, by doing fewer rain dances on average. (Plus, it reduced the variance of rainfall too, relative to the previous decades.)

[Philippe]

"if the average rainfall had previously been 40" (4%), and I told you to cut it to 20" (2%) for the next 20 years, could you deliver?"

Yes, but my tribe would have to move to a different part of the country, to prove their devotion to the Rain God. So sayeth the Holy Book of Rain.

[Mike Sproul]

Wong:
"When government sells Treasuries, it reduces the money base and the private sector holds less cash."

The government only holds the base money for an instant, if at all, before it is returned to the private sector by government spending. The government could choose to burn the cash, but that never happens.

"But if the the government redeems its own BONDS, the money base will expand as it has to return cash to the buyer."

The government had to get that cash from taxes, so once again the government only holds the cash for an instant before the cash is paid out for the bonds.

(Possible you are blurring the lines between the Fed and the government.)

"So I am not sure what BONDS are use to "buy back the extra money"."

The fed owns a pile of US government bonds, most of which it got by printing money and using the money to buy those bonds. (i.e., by conducting open-market purchases of bonds). The fed can sell those bonds for green paper dollars, which it stuffs back into the same printing press they came out of. This would be an open market sale of bonds.

"Are new Treasuries being issued or is government selling off commericial bonds to the corporate issuer to take back cash and thus reduces the money base?"

When the fed sells off its bonds, there's no reason to think the government is issuing new bonds. The two events are independent. Similarly, there's no reason to think the government is selling corporate bonds, or that the government ever owned any corporate bonds in the first place. But if the government did own corporate bonds, and sold them for green paper dollars, and burned those dollars, then the monetary base would fall.

It helps to think of silver. Suppose the Fed started business by receiving 100 oz of silver on deposit, and issuing 100 paper dollars in exchange. The paper dollar is just a receipt for 1 oz. The fed could, if it wanted, print another $200 and use them to buy 200 more oz of silver. The fed would then have 300 oz backing $300, so each dollar would still be worth 1 oz. (in spite of what Nick and his fellow quantity theorists might say!) The fed could, if it wanted, sell the extra 200 oz for 200 of the previously-issued paper dollars, and burn the dollars. Then we're back to 100 oz backing $100 cash. Now replace "silver" with "bonds", and you're on your way to understanding open-market operations.

[Sandwichman]

What happens to Bonds on steroids, Mike?

[Mike Sproul]

Bonds on steroids? Are they different from regular bonds?

[Majromax]

@Mike Sproul:

> Suppose the Fed started business by receiving 100 oz of silver on deposit, and issuing 100 paper dollars in exchange. The paper dollar is just a receipt for 1 oz. The fed could, if it wanted, print another $200 and use them to buy 200 more oz of silver. The fed would then have 300 oz backing $300, so each dollar would still be worth 1 oz. (in spite of what Nick and his fellow quantity theorists might say!)

That's contradictory. Your SilverFed is trying to target both the quantity of money in circulation and the price of silver at the same time, using only a single (reversible) policy instrument of "exchange dollars for silver".

History has shown with the gold standard that attempts to do this inevitably fail, as exogenous shifts in the price of the backing material cause a loss of the CB's metal reserves. In practice, maintaining this kind of dual standard requires close cooperation between the CB and government, whereby the government is committed to running a substantial surplus to defend the peg if necessary (that can take the form of taxation or confiscating silver reserves).

[Mike Freimuth]

Sandwichman: Without CP laws, you will have no economic theory. The issue isn't whether or not to rely on CP, it is what is worth including in the model and what is appropriate to leave under the CP umbrella. This is a tradeoff between tractability and accuracy. The reason we make such a commotion about other things being equal is because we are aware that we are usually leaving a lot of fairly important stuff there in order to get at some particular relationship that we think is important. We want to make sure students (or whomever) is cognizant that there is usually a lot of stuff behind the CP curtain that probably does matter in certain circumstances. But if you think you can come up with some kind of universal general theory of economics that doesn't have to assume anything, then good luck!