Does Money Printing Cause Inflation?

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Dan Buckley
Dan Buckley is an US-based trader, consultant, and part-time writer with a background in macroeconomics and mathematical finance. He trades and writes about a variety of asset classes, including equities, fixed income, commodities, currencies, and interest rates. As a writer, his goal is to explain trading and finance concepts in levels of detail that could appeal to a range of audiences, from novice traders to those with more experienced backgrounds.

The role of money supply in the economy is a hotly debated topic among economists, with its relationship to inflation being particularly controversial.

The traditional perspective suggests that an increase in money supply leads to inflation, while a transactions-based approach argues that it is the level of spending that primarily influences inflation.

The complexity of this debate is heightened by real-world occurrences, where at times the traditional perspective seems to be affirmed, while at others, the transactions-based approach seems more accurate.

Below we look into these perspectives.


Key Takeaways – Does Money Printing Cause Inflation?

  • The role of money supply in the economy and its relationship to inflation is a contentious topic among economists.
  • The traditional perspective suggests that an increase in money supply leads to inflation, while a transactions-based approach argues that it is the level of spending that influences inflation, not just how much money was created.
  • QE can stimulate economic growth by lowering borrowing costs but may also cause asset price inflation (distinct from real-economy inflation).


Traditional Perspective: More Money, More Inflation

Traditionally, economists have understood the relationship between money supply and inflation through the lens of the quantity theory of money.

This theory posits that if the money supply increases rapidly, the general level of prices will rise in tandem, leading to inflation.

In fact, this perspective is grounded in the concept that money and the value of goods and services are two sides of the same coin: when one increases without a corresponding increase in the other, demand exceeds supply, so inflation occurs.


The Quantity Theory of Money

This traditional viewpoint is crystallized in the quantity theory of money, which is often summarized by the equation MV = PT.

In this equation:

  • M is the money supply
  • V is the velocity of money
  • P is the price level, and
  • T is the total transactions

A large increase in the money supply (M), assuming a constant velocity of money (V) and total transactions (T), would lead to an increase in the price level (P), thereby leading to inflation.


Historical Precedents

Historical precedents lend credence to this traditional perspective.

A notorious example is the hyperinflation experienced by Zimbabwe in the late 2000s.

The Reserve Bank of Zimbabwe resorted to printing more money to fund the national budget, resulting in a peak inflation rate of 89.7 sextillion percent per month in November 2008.

In Weimar Germany in the 1920s, the government’s rampant money printing to pay off war reparations also led to one of the most dramatic hyperinflations in history.


Transactions-Based Perspective: It’s About Spending, Not Money Supply

However, using the transactions-based approach, one will see that it is not merely the increase in the amount of money that causes inflation, but the amount of spending.

After all, prices react to both the quantity of the item (e.g., house, financial security, household item) and the amount spent on it.

If an increase in the amount of money is offsetting a decrease in the amount of credit, it won’t make a difference to inflation.

This viewpoint argues that if the amount of credit is contracting and the amount of money is not increased, the amount of spending will decline, and prices will fall.

The most notable example of this was the QE period in the US from March 2009 to October 2014 (QE1, QE2, and QE3) where money creation was offsetting the fall in credit creation and this period did not produce any notable inflation, with the CPI rate generally between 0 and 2 percent.

However, what it did produce was asset inflation.

That’s because that’s where the money went.

QE involves buying bonds from the private sector. They then take the money and generally buy something similar.

Depending on the degree of QE, a lot of it can end up in the stock market.

However, the new wealth in the stock market doesn’t necessarily lead to more spending in the real economy to boost prices.

Asset holders tend to be wealthier and have a lower marginal propensity to spend and are more likely to keep money invested.


Money & Credit: Two Sides of the Same Coin

In this transactions-based perspective, money and credit are seen as two components of a larger whole.

If the amount of credit decreases, the supply of money needs to increase to prevent a decline in spending.

Therefore, the increase in money supply is not inflationary in this case because it is merely compensating for the decrease in credit.


Central Bank Money vs. Real-Economy Money

We can break down the answer further into two main categories:

  • the role of central banks in financial money creation and
  • the implications of real-economy money creation by governments and banks.

Central Bank Money Printing and Inflation

As mentioned, central banks engage in what is commonly referred to as “money printing,” primarily through QE and other monetary policy tools.

This process involves the central bank purchasing financial assets, like government bonds, from commercial banks, which increases the reserves of those banks.

However, these reserves are a form of financial money that is not directly accessible to the private sector, including businesses and consumers, for spending on goods and services.

The Misconception of Direct Inflationary Impact

A common misconception is that this increase in central bank reserves directly leads to higher inflation.

In reality, central bank money printing in the form of QE is aimed at increasing liquidity in the banking system and stabilizing financial markets rather than injecting money directly into the economy.

The reserves that are created in this process are used by banks for transactions with other banks or with the central bank itself.

But they don’t directly increase the money supply in the hands of the public which could lead to increased demand for goods and services – and, consequently, inflation.

Real-Economy Money Printing and Inflation

On the other hand, real-economy money is created through government deficit spending and bank lending.

This type of money directly impacts the economy because it increases the spending power of businesses and consumers.

Government Deficit Spending

When the government spends more than it collects in taxes, it injects new money into the economy, increasing the net financial assets of the private sector.

This increase in spending power can lead to higher demand for goods and services, which, if not matched by an increase in supply, can cause inflation.

Bank Lending

Similarly, when banks extend loans, they create new deposits in the borrower’s account, effectively creating new money that can be spent in the real economy.

If the pace of lending accelerates rapidly, it can lead to an increase in spending that exceeds the economy’s productive capacity, leading to inflation.


QE & Asset Prices

During QE, a central bank purchases government securities or other financial assets from the market.

This injects money into the banking system to lower interest rates and increase the money supply.

This new liquidity is aimed at promoting economic growth by making borrowing cheaper for businesses and consumers.

QE can also lead to asset price inflation, a situation where the prices of assets such as stocks, bonds, and real estate increase.

This occurs because the excess liquidity in the financial system, resulting from central bank asset purchases, often finds its way into financial markets rather than directly into the real economy.

As investors have more money to invest and the return on traditional investments like bonds is lower due to the reduced interest rates, demand for other assets rises, pushing their prices up.


FAQs – Does Money Printing Cause Inflation?

What Is Inflation and How Is It Connected to Money Printing?

Inflation is the rate at which the general level of prices for goods and services is rising and subsequently, the purchasing power of currency is falling.

Central banks aim to limit inflation – and avoid deflation – in order to keep the economy running smoothly.

Concerning money printing, it is often presumed that printing more money leads to inflation.

This is because, as more money is in circulation, the value of money can decrease relative to the supply of goods and services.

If there’s more money chasing a quantity of goods and services that lags the rise in money growth this could increase prices (assuming it gets spent).

Does an Increase in the Money Supply Always Lead to Inflation?

An increase in the money supply does not always lead to inflation.

It can lead to inflation if it outpaces economic growth, creating too much money chasing too few goods.

However, if there is a corresponding increase in the production of goods and services, inflation may not occur.

Moreover, if the money supply increase offsets a decrease in the amount of credit, it could maintain the balance, preventing inflation.

Why Did Quantitative Easing in the Post-GFC Period Not Produce Inflation?

Despite a substantial increase in the money supply as central banks bought large quantities of government bonds and other financial assets, the inflation rate remained relatively stable following the 2008 financial crisis.

In the United States, for instance, despite the Federal Reserve’s balance sheet expanding from about $900 billion in 2008 to over $4.5 trillion in 2015, the inflation rate remained under 2% for most of this period.

The reason, according to the transactions-based perspective, is that this increase in money supply was offset by a decrease in the amount of credit following the crisis.

What Role does the Velocity of Money Play in Inflation?

The velocity of money refers to the rate at which money is exchanged from one transaction to another.

It influences inflation because if the velocity of money increases, it means that a particular amount of money is being used to purchase more goods and services, leading to a potential rise in price levels.

If the velocity of money decreases, even if there’s an increase in the money supply, it might not lead to inflation if the money isn’t actually being spent.

What Effect does a Decrease in Credit have on Spending and Inflation?

If the amount of available credit decreases and the money supply does not increase to compensate for this contraction, the amount of spending can decline.

This reduction in spending can lower demand, potentially leading to a decrease in prices, or deflation, rather than inflation.

How Can Central Banks Control Inflation through Money Supply?

Central banks attempt to control inflation by managing the money supply through monetary policy.

This can include altering the interest rate to influence the amount of credit available.

Increasing the interest rate can decrease the money supply (by making borrowing more expensive) and reduce inflation, while lowering the interest rate can increase the money supply (by making borrowing cheaper) and potentially increase inflation.

Does Quantitative Easing Always Lead to Inflation?

Quantitative easing (QE) is a form of unconventional monetary policy where a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment.

While QE does increase the money supply, it does not necessarily lead to inflation.

This is because the banks and institutions (and others) that sell their securities to the central bank may choose not to increase their lending or spending in response, which can prevent an increase in inflation.

What are the Effects of Hyperinflation on an Economy?

Hyperinflation refers to a period of extremely high and typically accelerating inflation, often exceeding 50% per month.

It erodes the value of currency and can create severe economic instability.

This can lead to an increase in poverty and inequality, a collapse in the formal economy and increased reliance on the informal economy, and social unrest.



So, does money printing cause inflation?

The answer, as is often the case in economics, is “it depends.”

The relationship between money supply and inflation is complex and influenced by a range of factors.

It’s not a simple one-to-one correlation, but rather an interplay between money, credit, and spending.

Therefore, it’s important to consider both the traditional and transactions-based perspectives when trying to understand inflation dynamics.

Depending on the underlying economic conditions, an increase in money supply can either lead to inflation, as the traditional perspective posits, or have little to no impact if it is offset by a decrease in credit, as the transactions-based approach suggests.

This dichotomy shows the importance of considering a multitude of factors in economic policy decisions.

Rather than viewing money printing as inherently inflationary or benign, it’s essential to recognize its potential impacts in varying contexts.