Printing Money

by hilzoy

When I was little, I used to sit with my parents every evening and watch the news (or 'Huntley-Brinkley', as we called the news back then.) One night, probably in 1968, someone said something about Lyndon Johnson trying to pay for the war in Vietnam not by raising taxes but by printing money. It had never occurred to me that the President had the power to print money at will (I was, after all, eight or nine, and had never given printing money any thought at all.) But I thought it sounded like a pretty good way of paying for something expensive, like a war, so I asked Dadzoy: what's wrong with paying for a war by printing money?

Dadzoy said: imagine that you and I are the only people in the world, and I have a candy bar, and you have a dime. Also imagine that there is nothing else in the world that you want to buy, and no other money. How much would you pay me for my candy bar? Cleverly, I said: The whole dime! Right, said Dadzoy. Now suppose that right before you were going to offer to buy my candy bar, you found another dime. Now how much would you pay me for my candy bar? I said: I'd only offer you one dime. Dadzoy said: but if I knew that you had two dimes, I might ask for both of them. I thought for a while, and finally allowed as how I would pay both dimes for the candy bar.

So, said Dadzoy, do you think that finding that second dime made you any better off? Yes, I said: I had more money! -- But, said Dadzoy, even though you had twice as much money, you could still only buy one candy bar. Having twice as much money just made the candy bar more expensive.

The light dawned. This was cool!

Dadzoy went on: Do you think it would make any difference if you made that second dime instead of finding it? -- Of course not, I said. -- Well, that's what Lyndon Johnson is doing, and all that will happen is that everything will become a little more expensive.

Now: we could quibble about the details that Dadzoy simplified away to make this comprehensible to a nine year old: for instance, the fact that the economy has more than two participants, and that printing money can affect the distribution of stuff among them. (One of the nice things about the way Dadzoy explained it was that I could think of some of these things for myself and go back and ask him. And I did. Again and again.) Still, I think it was a great way to learn about inflation.

And that's why I very much wish that Dadzoy had had an opportunity to tell this same story to the young Robert Mugabe:

"President Robert Mugabe has promised to print more money to fund municipal projects, a government newspaper reported Saturday. The pledge came despite hyperinflation that has created severe shortages of cornmeal, meat, milk and other staples.

Meanwhile, water shortages have worsened because of pump breakdowns, and a senior government official said kidney patients were dying for lack of dialysis machines. (...)

"Where money for projects has not been found, we will print it," Mugabe was quoted as saying.

The printing of money is generally regarded as a recipe for inflation -- which is officially at 4,500 percent in Zimbabwe, though private economists estimate it to be at least twice that high. The government last month ordered sweeping price cuts of about 50 percent, accusing store owners and businesses of fueling the inflation.

Zimbabwe is in the grips of its worst crisis since independence from Britain in 1980. Power, water, health and communications systems are collapsing, and there are acute shortages of staple foods and gasoline. Unemployment is around 80 percent, and political unrest is high."

He needs the lesson about the dime and the candy bar. Then he needs the followup lesson about how once you start making a lot of dimes, controlling the price of the candy bar really isn't the answer. More than that, however, Zimbabwe needs a President who knows more economics than a nine year old can understand.

Comments

[Free Lunch]

Mugabe is still feeding resentment and hatred of the evil oppressors, but he seems completely oblivious to the fact that he has become the evil oppressor and is completely responsible for the destruction he is wreaking on the country and its economy. His departure from power by any means is absolutely necessary as a first step to keep Zimbabwe from the abyss.

[Count Cant]

I gotta say, hilz, of all the things wrong with Mugabe, his imperfect grasp of the nuances of Keynsian pump-priming theory are way, way down on the list.

I liked the story about wittle hilzoy and Dadzoy, though.

[hilzoy]

Count Cant: actually, I think that given what inflation is presently doing to Zimbabwe, it's gotten right up there with a lot of his other problems. I didn't mean to imply that his general thuggery is not a serious issue, though.

[Bernard Yomtov]

Inducing massive inflation is thuggery also. The worse it gets the more people hoard goods. This especially includes farmers, who will of course save their crops for themselves rather than, effectively, give them away. That leads to hunger in the cities, possibly even starvation, riots, etc.

Then the solution is to force the farmers to sell their crops. More thuggery ensues.

[mss]

As a political economist who often feels the lure to explain such things as price theory, money, and stock markets to curious laypeople, I commend nine-year-old Hilzoy for listening to the candy-bar-and-two-dimes example with an open mind. The real challenge lies less in teaching the non-intuitive parts of economics, but in being willing to suspend conventional thinking long enough to comprehend a simplified example.

Most people who "don't get" this sort of thing fail because thirty seconds into the story, they're interrupting with protests that "it doesn't work that way", "You're telling me the money I've used all my life isn't worth anything? Try earning some, wiseguy", and my personal favorite, "Maybe that's how it works in the ivory tower, but out here in the real world..."

Economic literacy would be much higher if people would reserve their objections (many of which are, after all, quite valid) until after they understand what economists are trying to say.

[obscure]

Niggling peeve: Is it 'printing money' or lowering the prime rate that actually increases the money supply (by making borrowed money cheaper)?

[noen]

(No)free lunch said "His departure from power by any means is absolutely necessary as a first step to keep Zimbabwe from the abyss."

Removing him would only plunge Zimbabwe into chaos so I can't see how that would help. There are no good solutions at this point. Only bad and really really bad.

Here in the US we have an equally stupid man running our country into he ground. In both cases I think the best solution is for a popular uprising to depose the thugs.

[Free Lunch]

obscure -

Whatever you call it, you're debasing the currency (the original way for the government to cheat). With gold and silver as currency, the government would shave the coins or mix inferior metals into the coins, a crime when private citizens did so. With paper as the major form of transaction, the government actually prints ever more money, cf Weimar and Zimbabwe.

It takes a fairly sophisticated economy to let the central bank funds rate drive the expansion of the monetary supply in an inflationary way. The prime rate is generally set by commercial banks as a result of the interest rate that the central bank sets. Sometimes, the central bank is stymied. Witness how Japan's central bank is stuck with an economy that won't grow even though their central bank lending rate is barely above 0%.

By the way, despite claims to the contrary, the prime rate does not exist in the United States in the way it had traditionally been defined. It's now a marketing tool, not an actual benchmark rate.

[hilzoy]

mss: I also commend Dadzoy not just for the original explanation, but for patiently answering all my many subsequent questions about possible variants on the original scenario. (And there were many, many variants, as there would be with any inquisitive nine year old once her interest was tweaked.) (And Dadzoy was just the warm-up for Grand-Dadzoy, who firmly believed that all his descendants should be economists, being one himself. Preferably, economists dedicated to exploring the further implications of his work. I leave you to imagine what happened when he discovered that I was actually interested.)

[double-plus-ungood]

Off-topic - Hilzoy, why does the link associated with your name take me to a July 14th ObiWi posting?

[JakeB]

dpu--
because her self-portrait is on one of the graphs? (I'm just guessing here.)

[Brett Bellmore]

Why not just assume that he has a 10 year old's grasp of the fact that printing money transfers wealth to the printer, (Him!) without a 10 year old's ethics? It's not like politicians never lie about why they're doing something.

[hilzoy]

d+u: I have no idea.

[hilzoy]

And what's odd is that I checked to make sure that no url was visible in the little box, and none was. So how it got there, I don't know. This time, I'll try replacing it with ObWi's home page.

[Free Lunch]

Removing him would only plunge Zimbabwe into chaos so I can't see how that would help. There are no good solutions at this point. Only bad and really really bad.

Agreed. I think we may disagree on which is the really really bad option. My prediction is that Mugabe is the really really bad option, while an insurrection is only the bad option.

[Jeff Eaton]

I just have to say at this point that the dadzoy stories are absolutely painfully awesomely sweet. I hope when I do the dad thing I can leave my daughter (or son) with those kinds of memories.

[obscure]

With paper as the major form of transaction, the government actually prints ever more money, cf Weimar and Zimbabwe.

Then what? Does it hand out notes on the street corners?

[Jack Robles]

Count Cant writes
"I gotta say, hilz, of all the things wrong with Mugabe, his imperfect grasp of the nuances of Keynsian pump-priming theory are way, way down on the list."
Just as a point of clarity, it is Milton Friedman who
said "Inflation is always and everywhere a monetary phenomomen."
A money pump, as I fuzzily recall, is an arbitrage scheme without limit. They are said not to exist, since arbitrage should eventually bring the prices in the two relevent markets into congruence. Of course, by the time that happens one might not care if he has an actual money pump or not.

[Slartibartfast]

If only Mugabe could stumble across a rich vein of ore, he could be cranking out Joachimsthalers by the truckload.

Which would have some inflationary effect, but at least you'd have some takers. I wonder if Mugabe's considered the history of money-printing?

[Free Lunch]

Then what? Does it hand out notes on the street corners?

Pretty much. It pays its bills with them. Rather than borrowing or collecting taxes, it just prints more and hands them out as payments. Inflation is generally tied to government deficits. As inflation increases and tax collections weaken and no one is willing to lend, they step it up.

[Davebo]

But remember what Carter told us (OK, a guy impersonating Carter on SNL).

Inflation is our friend!

Wouldn't you love to earn a million a year? Drive a 200,000 dollar car? Wear a 10,000 dollar suit?

Of course you would!

[Model 62]

The US Federal Reserve looks like it's trying the same trick (Money supply up 13% annually over the last few years, GDP up just 3-4%).

[Bernard Yomtov]

Then what? Does it hand out notes on the street corners?

One thing it does is pay off government debt. This goes by the name of "monetizing the debt."

[Curt Adams]

Mugabe isn't ill-informed, he's lost his mind, literally. He thinks a homosexual conspiracy has taken over the Brit government to oust him. He wasn't always so; this is a relatively new development. Not unknown in older people but it's not so common for somebody with absolute power to go crazy like this.

FWIW, it would be hard for Zimbabwe's prospects to be much dimmer. Mugabe is using the powers of the state to destroy the economy. It will become like Stalin's collectivizations or the Great Leap Forward. This will probably be as bad as a nasty civil war.

[Ralph Musgrave]

Hilzoy claims that printing money exacerbates inflation. My answer is "not necessarily".

During a recession it makes sense to print a bit of extra money so as to raise demand and hence raise employment levels, doesnt it?

Equally, given excess demand plus inflation, it makes sense for a government to do the opposite, i.e. destroy money. This is easily done by having government spend less than it collects by way of tax and borrowing.

Another circumstance where I would expect additional money to have little effect on demand or inflation is exactly what is going on at the moment, i.e. quantitative easing. This consists of governments buying securities, particularly the poisonous assets of banks. In as far a this prevents a systemic and catastrophic banking collapse, the effect will be to raise demand or at least prevent it collapsing.

However quantitative easing was taken much further in Japan over the last ten years. They printed money and bought up securities more or less willy nilly. This had precious little effect - exactly what I would expect. The reason is that if the owner of $10,000 worth of securities is given the equivalent amount in cash, they are not better off. So why would they suddenly go out on a spending spree?