Have you ever wondered why can’t the government just print more money to get out of debt? Or why can’t government just print new currency and distributes between all the low-income group of people?
I’m sure everyone has these questions in their childhood. And I’m pretty sure today this article will clear most of your doubts, about why we can’t print more currency to get out of debt?
If I offer you a bread worth Rs 200000, would you purchase it? Obviously NOT. No one will pay Rs 200000 for a simple bread. But the people of Zimbabwe paid the same not only for bread but paid million dollars for every need of living. Today I will tell you why Zimbabwe’s cost of living is higher than other country’s cost of living and why they are paying 200000 Rupees (Z$10 million) for just a bread.
In the time span from 1999 to 2009 the country of Zimbabwe was facing a sharp drop in food production and in other various sectors. And to overcome from these economic problems the government had taken a crucial step for reviving the economy back, was that was the excessive money creation and excessive money supply in the market. There were days when Zimbabwean dollar in its initial stage was more valuable than US dollar but after this step, not only the Zimbabwean dollar lost its value in the market as well as affected the economy in very harsh manner.
In the year 2007, there was a hike of inflation in the market, due to the excessive printing of new currency. The way they monetized their deficit, created a situation of hyperinflation in the economy and later on to overcome this they demonetized the Zimbabwean dollar and started using US dollars. This made their economy survive little more. Here’s the data related to how inflation rates increased in short span of time.
Let’s discuss this in brief:
MONETIZATION OF DEFICIT:
Here the term monetization of deficit refers to the situation where central bank purchases government’s bonds and securities to finance the needs of government or government’s expenses.
- It is also known as debt monetization, because it creates debt in the economy.
- In simple layman’s language monetizing deficit means covering the deficit by printing and supplying more money in the market or printing new currency rather than borrowing from public at every required moment.
- Deficit can be monetized in two manner i.e., direct and indirect.
- DIRECT MONETIZATION OF DEFICIT:
It refers to the situation where RBI (central bank) prints money to finance the deficit spending by the government. It’s a kind of borrowing which government takes from the RBI.
Under direct monetization government ask RBI to print new currency in exchange of their bonds and securities. Here printing new currency will increase the liability of RBI (as they promised to the bearer) and decreases the assets of government (the bonds and securities). Now the government have cash to spend for social purpose which will also help to reduce the stress in the economy as now government will be injecting more money in the market than usual which will lead to increase in purchasing power of customers.
Don’t get confuse between direct monetization of deficit and helicopter money they almost sound similar, in both situation money is injected in the market but the basic difference between these two is, resources raised by direct monetization are to be repaid in future by government to RBI, but in case of helicopter money, it is not repayable in nature.
In short term, it is good to use direct monetization because, for a healthy economy little inflation is much needed, but in long term there are some problems associated with it:
- Direct monetization of deficit will only fuels inflation.
- It will lead the problem of economic choice (for ex. Whom to help and at to what extent).
- Earlier, the direct monetization of deficit led to the balance of payments crisis in 1991. Then in 1994 Manmohan Singh (than finance minister) and C Rangarajan (than RBI governor), decided to end the facility of automatically (direct) monetization of deficit by 1997.
- Indirect monetization of deficit:
Indirect monetization of deficit is a situation where government sells their securities and bonds in secondary market. Government sells their assets to RBI, now the RBI holds the charge of selling these to public and finance the governments expenses.
Indirect monetization deficit holds less risk than direct monetization. Basic difference between these two is indirect monetization done through secondary market (open market operations) and direct monetization done through primary market.
But these exercises will lead to increase supply of money in the market which will automatically leads to inflation, as RBI prints new and fresh currency to buy the government securities and later on RBI will use these same securities to bring down the inflation by selling them in open market. So that’s why it acts like a monetary support to RBI as it helps them to suck extra money flow from the market which also helps in controlling inflation in the market.
SOURCES:
- WIKIPEDIA
- STUDY IQ
- DRISHTI IAS
- MINT.COM
- YOUTUBE
- THE HINDU ARTICLES
- AND OTHERS