Governments need (or want) to spend money. Perhaps the most obvious and time-honored means to finance that spending is via taxation. However, when the government concerned is a sovereign entity with the power to print currency, the question arises as to why it should resort to taxation at all. Why not simply print (or otherwise create ex nihilo) the money that it needs? The traditional response is that printing money leads to inflation, which is itself a form of taxation. It effectively redistributes from those who are least able to protect themselves from rising prices (e.g., retirees living on fixed income or employees without sufficient bargaining power to demand cost-of-living wage adjustments) to those who are able to protect themselves from rising prices and perhaps even to benefit from it. Furthermore, high inflation carries with it severe economic and political risks (Europe’s experience with hyper-inflation in the twentieth century is one reason why the mandate of the European Central Bank emphasizes price stability above all other goals).
However, for the past 13 years that theory has not seemed to play out in practice. Since 2008, the leading industrial economies have printed (again, to use the vernacular) trillions of dollars without producing inflation. This has led to the development of an alternative line of thought, known as “modern monetary theory” or MMT, which posits that printing money is essentially costless and should be used in place of taxes to fund government expenditure.
Professors Brian Galle and Yair Listokin take a middle path between conventional monetary theory and MMT. First, they argue that the advisability of financing spending by printing money will vary depending upon the circumstances. During recessionary times, it may be advantageous to print money in order to stimulate the economy (even to the point of dropping it from a helicopter, to use an image popular in the economic literature). Because of the decreased aggregate demand typical of an economy in recession, not only is there little risk of inflation but there is a substantial risk of deflation. Printing money to finance worthwhile public projects during a recession is doubly advantageous. At other times, printing money will cause inflation, along with all of the attendant societal costs. Second, and more broadly, they argue that the fact that in many situations monetary financing is not costless is not necessarily a reason to abandon it even at those times. Taxation itself is hardly costless. Economists estimate that the deadweight loss of taxation is roughly $.30 to $.50 for each dollar of revenue raised, i.e., it costs society between $1.30 and $1.50 to raise $1.00 of revenue. Consequently, from an efficiency perspective, central banks should continue printing money to finance government expenditure as long as the expected cost of additional inflation is less than the deadweight loss of raising funds through taxation (the authors explicitly refrain from commenting on the distributional aspects of monetary financing).
The authors further liken the opportunity to print money without causing inflation to non-renewable mineral wealth and propose adopting measures to spread out the benefit from such opportunity over a longer time frame.
Once point that I felt could benefit from further elaboration was in their discussion of the velocity of money, a concept that concerns how many times a year money changes hands. In the example that they give, if there is $1 million of cash in an economy that produces $5 million of goods and services a year, then the average dollar will need to change hands 5 times per year. They go on to state that if people are nervous about the future and decide to hold on to $800,000 in cash, then there will only be $200,000 of cash circulating and there will not be enough demand to sustain a $5 million economy. However, this would seem to hold only if people literally stuffed dollar bills into matrasses or a cookie jars. More likely those wishing to save for the future will deposit the money in bank accounts or purchase assets such as stocks, bonds, or real estate. Money deposited in the bank will be lent to other customers (why else would banks accept deposits?), and money used to purchase investment assets will now be in the hands of the sellers of those assets and will go on to spend it. An explanation of why such saving causes a decrease in demand for goods and services would be useful.
As the authors note, the circumstances that permit the seemingly limitless printing of money with no inflationary effect are not likely to be a permanent feature of the economy. It is therefore a worthwhile exercise to attempt to examine the phenomenon of monetary financing over the long term. This is certainly a cutting-edge issue in the field of public finance and the authors should be commended for their unique contribution to the literature.