The answer is NO. If the Central Bank starts to print money, there will be an inflation in the economy and the prices will rise high. And if the Central Bank prints too much money, the economy would enter the state of hyper-inflation and make our lives worse. Sounds unlikely? Read on.
Let us start with the most simple and fundamental concepts that will lead us to this conclusion.
Demand and Price
Think of how demand and price are related to each other. Fairly easy to do. Take an example of a product that you desire the most, say an Apple iPhone. If Apple brings down the price of its iPhone by 50%, certainly it will have more demand. Surely, an iPhone at 40,000 Rs. will sell lesser than the same at 20,000 Rs.
Thus, the demand of a product increases, if its price decreases.
Supply and Price
If the price of a product rises, the number of suppliers will increase. It is natural, that the sellers will supply as much as they can, because higher prices will earn them higher revenues.
Thus, higher the price of a product, more will be the supply.
Supply and Demand
Imagine that a special edition CD is out in the stores for 500 Rs. Assume that large number of these CDs are sold at this cost. Since the demand of these CDs is high, the price of the CD will rise. Consequently, since the price of the CD rises, the supply of these CDs will rise as well, as per the supply-price relationship.
Imagine that the demand for these CDs remain the same but the supply has increased. This is result in some CDs not sold at all. The suppliers will try harder to sell these CDs and lower its price. Now with a lower price, there will more people ready to buy these CDs.
If Central Bank prints lots of money
Suppose that the Central Bank prints money, and mails a share it to each and every living citizen of the country in an envelope. For the sake of a hyperbole, assume that every individual gets a sum of 1,00,000 Rs. in that envelope. Now, you are suddenly richer than what you were. Some people will save this money, some will pay off their debts and most of them will run down to their nearest shopping place and buy what they needed to buy, say a Samsung smartphone.
This sudden rise of the demand of products will pose as a problem for the shopping place, say Croma. Now, due to this rise in the demand for a Samsung smartphone, Croma is most likely to run out of stock for the same. Most logical thing for Croma to do is to raise the price of the Samsung smartphone so as to regulate this high demand. Rise in prices is equal to inflation. Thus, if Croma does that, it will cause inflation right away and the value of money will fall. But, assume, for an argument's sake that Croma will keep its prices constant. Now, to keep the price of Samsung smartphone constant, from what we learnt above, the supply of the phones to Croma must meet its demand from Croma by the consumers
For having the supply meet this rise in demand, Samsung will now have to increase its production of the smartphones. Certainly, this is almost impossible because with phones of such high demand, Samsung must already be using its full capacity to produce as many phones as they can. Still, if there is room for Samsung to increase the production, it will require more number of parts from its suppliers. To raise the bar of this exaggeration, assume that the suppliers supply the parts on time without raising their prices, there is another factor, which Samsung will have to deal with and that is labour.
For production of more smartphones, they’re going to need more man hours of labour. Wages are essentially prices; an hourly wage is the price a person charges for an hour of labour. It will be impossible for hourly wages to stay at their current levels. Some of the added labour may come through the current workers working overtime. This clearly has added costs, and workers are not likely to be as productive (per hour) if they’re working 12 hours a day than if they’re working 8. Many companies will need to hire extra labour. Thus, the cost that is incurred upon the company will rise as the company will have to pay to more number of workers. They’ll also have to influence their current workers not to retire. Since every person has been 1,00,000 Rs. by the Central Bank, some of them will not do their job unless their wage/salary is increased. Thus, from one way or the other, the cost involved in manufacturing a product in this case is going to be reflected in the smartphone's final price, thus causing inflation.
In short prices will go up after a drastic increase in the money supply by the Central bank because:
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Let us start with the most simple and fundamental concepts that will lead us to this conclusion.
Demand and Price
Think of how demand and price are related to each other. Fairly easy to do. Take an example of a product that you desire the most, say an Apple iPhone. If Apple brings down the price of its iPhone by 50%, certainly it will have more demand. Surely, an iPhone at 40,000 Rs. will sell lesser than the same at 20,000 Rs.
Thus, the demand of a product increases, if its price decreases.
Supply and Price
If the price of a product rises, the number of suppliers will increase. It is natural, that the sellers will supply as much as they can, because higher prices will earn them higher revenues.
Thus, higher the price of a product, more will be the supply.
Supply and Demand
Imagine that a special edition CD is out in the stores for 500 Rs. Assume that large number of these CDs are sold at this cost. Since the demand of these CDs is high, the price of the CD will rise. Consequently, since the price of the CD rises, the supply of these CDs will rise as well, as per the supply-price relationship.
Imagine that the demand for these CDs remain the same but the supply has increased. This is result in some CDs not sold at all. The suppliers will try harder to sell these CDs and lower its price. Now with a lower price, there will more people ready to buy these CDs.
If Central Bank prints lots of money
Suppose that the Central Bank prints money, and mails a share it to each and every living citizen of the country in an envelope. For the sake of a hyperbole, assume that every individual gets a sum of 1,00,000 Rs. in that envelope. Now, you are suddenly richer than what you were. Some people will save this money, some will pay off their debts and most of them will run down to their nearest shopping place and buy what they needed to buy, say a Samsung smartphone.
This sudden rise of the demand of products will pose as a problem for the shopping place, say Croma. Now, due to this rise in the demand for a Samsung smartphone, Croma is most likely to run out of stock for the same. Most logical thing for Croma to do is to raise the price of the Samsung smartphone so as to regulate this high demand. Rise in prices is equal to inflation. Thus, if Croma does that, it will cause inflation right away and the value of money will fall. But, assume, for an argument's sake that Croma will keep its prices constant. Now, to keep the price of Samsung smartphone constant, from what we learnt above, the supply of the phones to Croma must meet its demand from Croma by the consumers
For having the supply meet this rise in demand, Samsung will now have to increase its production of the smartphones. Certainly, this is almost impossible because with phones of such high demand, Samsung must already be using its full capacity to produce as many phones as they can. Still, if there is room for Samsung to increase the production, it will require more number of parts from its suppliers. To raise the bar of this exaggeration, assume that the suppliers supply the parts on time without raising their prices, there is another factor, which Samsung will have to deal with and that is labour.
For production of more smartphones, they’re going to need more man hours of labour. Wages are essentially prices; an hourly wage is the price a person charges for an hour of labour. It will be impossible for hourly wages to stay at their current levels. Some of the added labour may come through the current workers working overtime. This clearly has added costs, and workers are not likely to be as productive (per hour) if they’re working 12 hours a day than if they’re working 8. Many companies will need to hire extra labour. Thus, the cost that is incurred upon the company will rise as the company will have to pay to more number of workers. They’ll also have to influence their current workers not to retire. Since every person has been 1,00,000 Rs. by the Central Bank, some of them will not do their job unless their wage/salary is increased. Thus, from one way or the other, the cost involved in manufacturing a product in this case is going to be reflected in the smartphone's final price, thus causing inflation.
In short prices will go up after a drastic increase in the money supply by the Central bank because:
- If people have more money, they’ll divert some of that money to spending. Retailers will be forced to raise prices, or run out of product.
- Retailers who run out of product will try to replenish it. Producers face the same dilemma of retailers that they will either have to raise prices, or face shortages because they do not have the capacity to create extra products and they cannot find labor at rates which are low enough to justify the extra production.
- Supply of money increases
- Supply of goods decreases
- Demand for money decreases
- Demand for goods increases
A very thorough evaluation. Good post.
ReplyDeleteThank you very much Mr. Licari.
DeleteCentral Bank prints money on the basis of assets held by her. Thus, the value of the printed money shall be determined based on the assets she has to back it. For example, say the asset is a banana. If the bank has 1 banana in its treasury and the bank prints Rs. 10, then it would mean that the value of each Rupee is worth 1/10th of a banana. That is to say that a Rupee can fetch only 1/10th of a banana or Rs. 10 can fetch a banana. Now, if the next day, the Central Bank prints Rs. 90, but it still has 1 banana in her treasury, then the value of Rs. 100 (Rs. 10 of Day 1 + Rs. 90 of Day 2), shall be represented by that 1 banana in her treasury. Thus, the value of each Rupee is 1/100th of a banana or to fetch a banana, one needs Rs. 100 (as opposed to Rs. 10 earlier). This is called inflation. Thus, money can be printed by the Central Bank so long as she has the assets to back up the value of it. When money is printed without asset-backing, it leads to inflation.
ReplyDelete[PS: Central Banks do not use bananas, but rather resort something more appropriate like gold bullion and foreign exchange reserves as assets against which to print money. Bananas are used primarily for eating]
nice 1....
ReplyDeletedone lot of research to write this blog