Currency printing: The new versus the old macro?

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In India, often we find conventional ideas and policy playbooks as the go-to tools for dealing with economic ideas. Thus, unorthodox ideas are often viewed with suspicion as policymakers attempt to minimize the risks by using the tried and tested ideas. The same was largely true even for much of the world until the 2008 crisis, which put to test the conventional macroeconomic handbook.

The discussion in the advanced part of the world has pertained to slowing growth, secular stagnation and whether their economies have witnessed a reduction in their potential growth rates despite stimulus measures. The pandemic further resulted in policymakers resorting to unconventional policy measures and sizeable fiscal interventions. Of course, there are still several debates in the west about the potential implications of these policies – but unconventional measures are no longer as unconventional as they used to be as they are becoming a mainstream part of the macroeconomic policy handbook.

The same is also true for India as the government did intervene with a sizeable fiscal stimulus comprised of various types of expenditures. These were supplemented by monetary and macroprudential policy interventions to further assist the growth recovery. But India’s adoption of the new macro somewhat predates the pandemic as the RBI intervened using operation twist, which includes simultaneous sales and purchase of government bonds.

However, there seems to be a debate on the issue of printing of currency and its implications for inflation and economic stability in India. Money9 wrote an excellent editorial on this which can be accessed by clicking here.

The argument

Many have argued that simply printing currency will be inflationary, and thus governments should avoid printing them. There is an issue with this argument. The conventional macro would argue in simpler terms that creating more money in the system will increase the demand for goods and services, which cannot be supplied in the short run. As a consequence, there will be an increase in prices to ensure that markets clear. (For classical macro enthusiasts the Walrus law provides a nice interpretation for this when one views the nth good as money.)

However, the important point that many analysts have missed lately is that the constraint comes from the supply side. That is, the reason why prices may increase pertains to the inability of supply to service that demand – and the time it takes to put up with additional capacity in the economy to meet the same. Or, in other words, supply cannot shift in the short run, which is why excess demand created by simply printing more money would be inflationary.

The reason why printing currency today may not lead to inflationary impulses is that there is an additional capacity that is available in the domestic economy. Therefore, even if there is some printing of currency, it may not lead to inflation given that the economy is functioning well below the potential growth rate. Modern Monetary Theory too suggests that inflationary risks associated with printing of currency are only valid when the economy is close to the full employment level. Therefore, as long as there is a deficient demand in the system, expanding the money supply can help without any inflationary risks.

This does not mean that governments can spend as much as they want under every circumstance, but what it means is that the real constraint to the use of monetizing of deficits are inflation and on the external front. In the event of an economy with permanent slack, these constraints are not binding, and thus, policymakers can use this tool as an instrument of their macroeconomic policy. Several countries have in fact used this proactively during the present pandemic.

Concerns of inflation

Some may argue that inflation has picked up over the last few months, but the response to that is to see the extent of the inflationary pressures while keeping in mind that the supply constraints are still prevalent. Thus, these pressures would ease out as supply chains are restored. Many have now started to even express fears about deflation given the prospects of a reversion to modest growth in most parts of the world over the next 3-5 years. At this point, it is instructive to remember that inflation is likely when wages start to pick up, and thus, given the nominal wage cuts during the pandemic, a sustained increase in inflation persistence appears less likely.

On the issue of currency, many analysts have viewed the problem statement in isolation. That is, if India prints currency, then it will adversely impact the rupee. Such assessment ignores the complexity of the global economic system – more so as India is not the only country that has provided some form of policy support to its economy. The US, the UK, and most countries have made massive monetary and fiscal stimulus.

Therefore, a modest response from India is unlikely to spell the kind of trouble that has been highlighted by most analysts. Keep in mind, that the trouble in 2013 originated on the external front when the rest of the world began unwinding its stimulus policies while we were behind the curve. As long as we use these new tools in moderation and coordinate the unwinding of the stimulus policies, there are fewer risks of it leading to any volatility on the exchange rates.

New macro playbook does provide us with powerful tools and new instruments for providing stabilizing support to our economies – this includes printing of currencies and using it to provide support to the government borrowing program. If done in moderation, they do not have many risks either on the inflationary or the exchange rate front. Instead, the concern should be our reluctance to use these tools – which could lead to slower growth that can create problems for our debt sustainability. Thus, we must embrace the new macro and use these tools in a prudent manner to accelerate the pace of growth and help restore our macroeconomic fundamentals.

(The writer is a New Delhi-based economist & policy researcher)