Why We Can’t Just “Stop Printing Money” to Bring Down Inflation

Jacqueline Best, Professor, School of Political Studies, the University of Ottawa.

With the Bank of Canada’s announcement of a disproportionate increase in interest rates this week, it could seem that the central banks are once again coming to save us from inflation. Yet, despite playing an important role in mitigating a COVID-induced recession, central banks lack the power to solve our inflation problem.

There is no doubt that the outlook for inflation today is worrying. With inflation hitting 5.7% in March in Canada, we are facing a perfect storm of inflationary pressures resulting from a combination of supply chain bottlenecks, pent up demand and massive increases energy prices resulting from Russian sanctions.

As politicians start making noise about inflation, we must be careful not to accept the outdated assumption that central banks can control inflation by limiting the money supply.

Conservative Party leadership hopeful Pierre Poilievre recently affirmed that the solution to inflation is “to prevent the central bank from printing money to pay for government spending”. This is not only factually incorrect (the Bank of Canada stopped buying large amounts of government bonds in October last year), but also outdated.

The legacy of monetarism

In the late 1970s and early 1980s, Ronald Reagan and Margaret Thatcher capitalized on public concern over rising prices by bringing their conservative governments to power on a promise to crack down on inflation using monetarism.

We should therefore not be too surprised to see the legacy of this antiquated economic policy being carried on among members of the Conservative Party of Canada.

A man in a suit speaking into a microphone
Conservative leadership hopeful Pierre Poilievre is following in the footsteps of his political predecessors in suggesting that inflation is caused by too much money circulating in the economy. THE CANADIAN PRESS/Patrick Doyle

Poilievre resurrected the age-old theory – let’s call it quack monetarism – that inflation is caused by too much money circulating in the economy and that the solution is to reduce central bank money creation. Inflation has never been just about money; central banks cannot simply wave a magic wand and let it fall.

The limits of monetary policy

Although central banks play an important role in controlling inflation by setting interest rates, they do not have all the tools necessary to bring inflation down this time around, especially when some of the dynamics causing price increases will not respond to changes in interest rates.

As writer Adam Tooze points out, monetary policy cannot ameliorate bottlenecks in microchip supply — which drive up car prices — or increase gas supply.

Even when monetary policy is effective in bringing down inflation, there is always the risk that the central bank will overshoot its targets and push the economy into a recession – as a growing number of policymakers may worry today. today.

Quack monetarism

So why do conservative politicians like Poilievre want us to believe we can solve this problem by getting the central bank to stop printing money? It’s the kind of “zombie idea” that won’t die, even if it’s been debunked, so politically appealing is its simplicity.

This assertion refers to Milton Friedman’s famous maxim that inflation is “always and everywhere a monetary phenomenon”. The monetarist theory championed by Friedman and which became very influential in the 1970s and early 1980s assumed that the solution to inflation was to limit the expansion of the money supply.

What’s wrong with this idea? American banker Henry Wallich responded to Friedman’s statement by saying, “Inflation is a monetary phenomenon in the same way that shooting someone is a ballistic phenomenon.” In other words, excess money can be partly to blame for inflation, but if you really want to fix it, you need to understand the underlying causes of the problem.

A man using an ATM
Each time we face a new inflation-related challenge, it takes a different form and requires a different set of solutions. THE CANADIAN PRESS/Graham Hughes

As political economist Matthew Watson has shown, economists keep changing their minds about the broader causes of inflation: from pointing the finger at international balance of payments shocks in the 1960s to the oil crisis in the 1970s, the “wage-driven” inflation in the 1980s, the lack of anti-inflationary credibility of governments in the 1990s and finally the problem of unanchored inflation expectations in recent decades.

Even if today’s inflation had similar causes to those of the 1970s, we don’t want to try monetarism again. The central banks of Canada, the United States, and the United Kingdom all tried it in the late 1970s. By 1982 they had given up on it because monetarism just didn’t work.

Most money is actually created by private banks, and central bank attempts to limit the money supply are therefore doomed to failure. The bank can influence the demand for money by raising or lowering interest rates, but it does not control the money supply itself.

Monetary policy is a blunt instrument

What ultimately brought inflation down in the 1980s was a combination of extremely high interest rates – over 21% in Canada – and the most painful recession since the Great Depression, with unemployment reaching 12.8% in Canada. It is not an experience that we wish to repeat.

If the economic trauma of the 1970s and 1980s teaches us anything, it is that monetary policy can be a very brutal instrument. To be truly effective, it must often be brutal.

Although there are no simple solutions to our current inflationary challenges, it is clear that we need a holistic approach. US President Biden’s recent strategy offers a promising alternative. Its aim is to fight inflation by urging businesses to cut costs, rather than wages, and by making prescription drugs, energy and childcare more affordable.

So the next time a politician tries to sell you a quack monetarist remedy for our current inflationary woes, ask him if he’s prepared to make us pay at all costs for another historic economic blunder.The conversation

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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