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How Central Banks Print Money and Why It Matters: The Pros and Cons of Permanent Monetary Stimulus



Can Central Banks Keep “Printing” Money/Currency Forever? Permanent Monetary Stimulus

The COVID-19 pandemic has triggered unprecedented responses from governments and central banks around the world. To support the economy and prevent a financial meltdown, many central banks have resorted to “printing” money or currency, or more accurately, creating new money electronically. This process is also known as quantitative easing (QE), which involves buying government bonds and other assets from the market to increase the money supply and lower interest rates.

But can central banks keep doing this forever? What are the benefits and risks of permanent monetary stimulus? And what are the alternatives?

The Benefits of Monetary Stimulus

Monetary stimulus is intended to boost economic activity by making borrowing cheaper and encouraging spending and investment. By increasing the demand for goods and services, monetary stimulus can also support employment and income growth. In addition, monetary stimulus can help prevent deflation, which is a sustained decline in the general level of prices that can undermine consumer and business confidence and lead to a vicious cycle of lower spending and lower growth.

Monetary stimulus can also have positive spillover effects on other countries, especially those that trade with or borrow from the countries that implement QE. For example, the QE programs of the US Federal Reserve, the European Central Bank, and the Bank of Japan have helped lower global interest rates and ease financial conditions for emerging markets and developing economies.

The Risks of Monetary Stimulus

However, monetary stimulus is not without risks and limitations. One of the main risks is that it can create asset bubbles and financial instability. By lowering interest rates and increasing the availability of credit, monetary stimulus can fuel excessive risk-taking and speculation in financial markets, leading to overvaluation of assets such as stocks, bonds, real estate, and cryptocurrencies. If these bubbles burst, they can trigger a sharp correction in asset prices and a loss of wealth for investors, which can have negative consequences for the real economy.

Another risk is that monetary stimulus can erode the value of money and cause inflation. By creating more money than the economy needs, monetary stimulus can reduce the purchasing power of money and increase the cost of living for consumers. This can especially hurt those who rely on fixed incomes or savings. Moreover, inflation can undermine the credibility and independence of central banks, which are supposed to maintain price stability as their primary objective.

A third risk is that monetary stimulus can create fiscal dominance and moral hazard. By buying government bonds, central banks can effectively finance government deficits and debt, which can reduce the pressure on governments to pursue sound fiscal policies and structural reforms. This can create a situation where fiscal policy dominates monetary policy, limiting the ability of central banks to respond to inflationary pressures or financial shocks. Furthermore, by providing cheap funding to governments, central banks can also create moral hazard, which is a tendency for governments to take excessive risks or behave irresponsibly because they expect to be bailed out by central banks.

The Alternatives to Monetary Stimulus

Given these risks and limitations, it is unlikely that central banks can keep “printing” money or currency forever. At some point, they will have to unwind their QE programs and normalize their monetary policies. This will involve selling some of the assets they have bought and raising interest rates to more appropriate levels. However, this process will not be easy or smooth. It will require careful communication and coordination among central banks and with other policymakers to avoid market disruptions and adverse feedback loops.

Moreover, monetary policy alone cannot solve all the economic challenges facing the world today. It needs to be complemented by other policies that can address the underlying causes of low growth, high debt, inequality, climate change, and other structural issues. These policies include fiscal policy, which involves government spending and taxation; macroprudential policy, which involves regulation and supervision of the financial system; structural policy, which involves reforms in labor markets, product markets, education systems, innovation systems, etc.; and international policy cooperation, which involves coordination and collaboration among countries on trade, investment, taxation, development assistance, etc.

In conclusion, monetary stimulus has been a useful tool for central banks to support the economy during times of crisis. But it is not a panacea or a free lunch. It has benefits but also risks and limitations. And it cannot be sustained indefinitely without causing serious problems. Therefore, central banks need to be prudent and vigilant in implementing monetary stimulus. And they need to work with other policymakers to find more balanced and sustainable solutions for the global economy.

References:

1 Myth-Busting: Money Printing Must Create Inflation | CFA Institute Enterprising Investor 2 Banknote production and stocks - European Central Bank 3 Is the Federal Reserve Printing Money? - The Balance 4 What is money? - European Central Bank 5 Explainer: What is ‘money printing’? - Times of India 6 Side effects of monetary easing in a low interest rate environment: reversal and risk-taking - European Central Bank 7 What Is Economic Stimulus? How It Works, Benefits, and Risks - Investopedia 8 Stimulus Check - Overview, Impact, and Effectiveness - Corporate Finance Institute

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