MainStreet Macro: Why can’t we just print more money?

This week, I have a timely and thoughtful question from a 10-year old viewer, Caleb: “Ms. Nela, could you share with us why we can’t just print more money to fix the economy?”

Well, Caleb, that’s a very good question, one that’s of particular importance to Main Street right now.

When it comes to printing money and fixing the economy, there are three things to know.

Why does this matter now?

Since the pandemic began, the federal government has allocated $5.3 trillion in federal relief, money needed to help the economy weather its worst downturn since the Great Depression.

That aid has sent the federal debt, as a share of the economy, to its highest level since World War II, and it’s likely to grow even bigger. Congress is working on a $2.3 trillion infrastructure proposal from President Joe Biden that would support the economy longer term. 

Even without the new infrastructure spending, the federal debt as a share of the economy is estimated to almost double in the next 30 years, from 129% now to more than 200%, because of rising healthcare costs and interest on our borrowing.

Economists are fond of saying there’s no such thing as a free lunch, which means someone eventually has to pick up the tab for our feast. That responsibility likely will fall to Main Street business and consumers in the form of higher taxes.

In the spirit of Caleb’s question, a small but growing chorus of economists and policymakers recently have thrown their support behind an unconventional idea called Modern Monetary Theory, a full-throated endorsement of printing money to fix the economy.

The theory’s supporters argue that wealthy countries like the U.S., which are able to issue debt in their own currency, never have to worry about spending too much. They can never go bankrupt because they can always print more money.

How does it work?

There’s not an actual printing press or consortium of elves in the basement of a country’s finance division churning out new dollar bills to fund government spending (though this would be a fun animated movie). Instead, money creation happens with a few strokes of a computer keyboard at a country’s central bank.

To print money to fund its spending (or more formally to “monetize debt”), the government directs its treasury to issue debt in the form of bonds, which are purchased by the country’s independent central bank — the Federal Reserve in the case of the U.S.

These purchases effectively increase the amount of money in circulation, which makes its way to businesses and consumers through the banking system in the form of cheap or easy-to-get loans. Theoretically, the Fed could buy bonds indefinitely. That would allow the U.S. to just repay old debt with new debt, without ever paying it all off.

In practice, the Fed uses bond purchases to encourage spending and investment. Currently, the central bank is buying $80 billion in U.S. Treasurys and $40 billion in government-backed mortgage securities each month to stimulate the economy.

What could go wrong?

In a word, inflation. All those newly printed dollars chasing too few goods produced in a still-recovering economy can cause prices to rise.

I asked my 13-year old son Jaden, a resident fellow of the MainStreet Macro domestic policy committee, to explain the inflation risks associated with rising consumer demand at a time when millions of people are out of work due to the coronavirus pandemic.

“The more money that’s made, the less valuable it is. But just because the money is less valuable doesn’t mean people get paid more money,” Jaden said. “That means things get more expensive.”

See why I hired him? Kid, I’m raising your allowance (but not too much, because inflation). 

Until last month, the rate of inflation was actually shrinking in the first two months of this year. The U.S. consumer price index, minus volatile food and energy prices, fell to 1.3% in February before jumping to 1.6% in March, data last week showed. The Fed likes to see inflation at a goldilocks level of 2% – not too hot to overheat the economy, not too cool to be a drag on economic growth.

As we head into spring, several recent indicators point to strong consumer demand, which could push up inflation from its current modest levels. Last month, growth in retail sales soared past what economy-watchers thought was likely, hitting nearly 10%.

Retailers got a boost from the $1,400 stimulus checks that began landing in consumer bank accounts in March. But there also is evidence that Main Street is spiffing up its wardrobe and going for a night out as the economy returns to normal and more people are vaccinated. Clothing purchases were up 18%; spending on food and drink rose 13.4%.

But here comes trouble. Surveys of the manufacturing and service sectors warn of shortages in lumber, semiconductors, and even workers. These logjams in production could spill into what consumers pay for goods and services, causing prices to rise.

Strong demand and short supply are fertile ground for inflation, especially in the presence of massive government spending and near rock-bottom interest rates.

My Take

So, Caleb, to answer your question, in some ways the government already is printing money – it’s spending more and borrowing more, and its independent but accommodative central bank is buying a portion of that debt in the form of bonds.

However, there are limits.  If inflation veers upwards, it could lead to a spiral of ever-rising prices that is really hard to control. The money we have could become less valuable.

Inflation is still quite modest and not a concern despite our record federal debt. But keeping it in check in the long run requires more than just printing money. We need to figure out how to pay for all our spending soon, so that your generation isn’t burdened by your parents’ debt.