Printing Money - a Misleading Metaphor for Solving the Global Economic Crisis

By Eugenie Foster

'Quantitative easing' is the latest term in the financial lexicon to seep into the public domain. The more prosaic term is 'printing money'; the idea behind this is that, by flooding their systems with more money than  can metaphorically be stored under the mattress, central banks will  encourage the lending banks to provide credit to the wider economy, kick- starting economic activity and preventing deflation. But suppliers shouldn't be too excited about the prospect of printing presses being ramped up since the term, in this day and age, is simply a metaphor. Eugenie Foster, formerly of the Board of Governors of the Federal Reserve System and an advisor to Currency News, explains why and the risks involved.

Much has been made in the news recently about central banks 'printing money' in response to the global economic crisis. On television, I often see film of sheets of banknotes going through a press as the pundits talk about the financial system bailout. Would adopting a policy of 'printing money' -either as an objective of monetary policy or to help finance governmental spending aimed at stimulating the economy- create a new era of prosperity for banknote printers and suppliers, in counterpoint to the economic crisis?

 For centuries, sovereigns and governments printed banknotes (or minted coins) to raise funds and settle their obligations, but in many economies today, banknotes are only a small component of money.  Most transactions are settled electronically, with credit and other account transfers. As of December 31, 2008, currency in circulation for the US, ECB countries, and Japan represented about 9-10% of M2, the most common measure of the money supply.

Nevertheless, there are countries where the population is largely unbanked and most transactions are in cash.  At the extreme, in Zimbabwe, the central bank has been literally printing money, resulting in the greatest inflation on record, loss of confidence in its currency, and the recent approval of foreign currency use for local transactions.

It is this example,  or looking further back into history during the Weimar Republic in 1920s Germany when cash for basic commodities had to be carted around in barrows, that may influence public perception of what the term 'printing money' means.

Central banks normally acquire banknotes for their account holders to satisfy demand from the public for transactions and to be held as a store of value. Banknote orders are forecast based on the number of notes needed to replace unfit notes destroyed, adjusted to reflect anticipated growth or reduction in demand.

Central banks also adjust their purchases of banknotes for various cost or operational reasons. Some buy extra notes to take advantage of volume pricing or excess capacity at the security printer. Others may smooth yearly orders to minimize significant production fluctuations that affect security printer efficiency.

Central banks also manage banknote orders to assure sufficient contingent inventory in the event of emergencies such as natural disasters that affect the banking system.

What responsible central banks do not do, however, is order more banknotes to pay their bills.

So, are the central banks literally printing money to address the current economic crisis? The short answer is no - this is simply a metaphor for turning up the money supply, but for details I look to the central banks.

In recent months, the governors seem to have been on a campaign to communicate to the public the nature of the economic crisis and the actions that their banks have taken to respond to it. While the governors' messages reflect local circumstances and points of view on recent events, the main points are remarkably similar: the crisis is global, and the central banks are taking measures extraordinary by past standards to address the problems.

There are differences in the central bank strategies: the Federal Reserve System is lending directly to non-bank issuers of commercial paper, while the ECB lends only to its account holders. The Bank of England held out the Bank of Spain's system of pooled reserves as a possible approach to future financial stability. The Bank of Thailand pushed for greater economic integration among Asian nations. Some like the Federal Reserve supervise banks, while others, including the Bank of England, the ECB, and many others do not, but work closely with and influence national financial system regulators.

But all agree that the central banks are playing an essential role in addressing the current problems which are, by almost any accounting, of historic proportions. They look for the lessons of the Great Depression of the 1930s, the Japanese 'Lost Decade' of the 1990s (when the term quantitative easing was first coined), and the Swedish banking crisis of 1992.

It is unclear whether the current measures are the right ones.  The leaders of the central banks are students of past economic crises and they believe the risks of such action are less great than the risk of inaction. A return of confidence will require public acceptance of that belief.