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Why don’t we Print Money and Pay off all our Government Debt?

I was talking with a friend the other day and she asked me why government debt matters. “Can’t governments just print more money to pay their debts”? The answer is yes, they can. Although the subject of another article, countries can, and continually do create new money supply (through the central banks). And theoretically, they could create as much of that money as they want and use that money to pay off their debts (I’ll avoid the discussion of the independence of central banks as well).

And because money does seem to be “free” for governments, almost all developed countries have significant debt, generally more than 50% of the entire annual economy (Gross Domestic Product = GDP). For example, in 2017, Canada’s debt as a % of GDP was around 90%. That means that, to pay off the debt, Canada would need to (somehow) take all the economic production of the entire country for a year and put that to paying off the debt. Obviously, that’s not possible. But because a country is unlikely to go bankrupt (but it has happened – Greece is the most recent example), they can borrow huge amounts of money, sometimes much more than the country’s annual GDP (chart source – Wikipedia).

So, back to the question at hand, why not just print more money and pay off the debt? To understand why not, the relationship between money supply and inflation must be understood.

Let’s take a simple example. Assume there are only 3 people live in a country on a deserted island – Ann, Bob and Chuck. Each has $10 of the country’s currency and they use it to buy the country’s only commodity – rice. There is only so much rice (30 kg each month) and the price of rice is $1/kg ($30/30kg of rice) since all the money can only be used to buy rice and each person wants to get the most rice they can. So, with their $10, each of the people can buy 10 kg of rice. So, now the “central bank” of our little island country prints $90 more for each person on the island and now everyone has $100. There is still only 30kg of rice to buy so the price of the rice now rises to $10/kg as all of the inhabitants try to pay more to get more rice. The price rise from $1/kg to $10kg is called inflation and that’s what happens if a central bank were to print a lot of money.

The most extreme example of this actually happening was in of Zimbabwe in 2015. Zimbabwe experienced what economists called hyperinflation where they printed money with little increase in production. Prices skyrocketed as happened on our island. At its peak, the price of one loaf of bread cost 35 million Zimbabwe dollars and their currency had a value of 35 quadrillion dollars to 1 USD. Check out the one hundred billion dollar bill in the picture.

So, countries very carefully manage their money supply (not print too much money) to keep inflation in control. That’s the reason countries don’t print money to pay off their debt.

#inflation #debt #monetarypolicy

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All articles herein are presented as an educational resource and should not be considered as professional financial or individualized investment advice. Readers should always exercise their own judgement when making any decisions about their money.