Does it terrify you that this man has the President’s ear in economic matters?
Here is a video of President Biden’s Chairman of the Council of Economic Advisors trying to explain, well, you use your own judgment. I’m not sure what he’s trying to explain.
Does it terrify you that this man has the ear of the president on economic matters?
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Who is This Guy?
Jared Bernstein is the chairman of President Biden’s Council of Economic Advisors. In that role, he has the ear of the President, and significant influence over economic policy. Unlike most of the prior chairmen and chairwomen of the Council, Mr. Bernstein has no formal training in economics. He has degrees in music, and social work.
As Mr. Bernstein is apparently unable to explain the difference between the government printing money and borrowing it, we’ll do so.
What’s Wrong With Printing Money
From an economic (not a legal) point of view, there is no distinction whatsoever[1] between new money created by illegal counterfeiting and new fiat money created by legal processes.
In the 18th century, French Physiocrat economist Richard Cantillon[2] explained how new money (whether legal or illegal), enters the economy and how the resulting effects spread. These effects are known as Cantillon Effects, which we’ll explain below. I don’t know whether Bernstein has ever heard of Cantillon, but in the video, Bernstein demonstrates no understanding of the inevitable effects of the government printing money to pay its bills.
In brief, the Cantillon Effect describes how a select few people (typically the politically connected) benefit from inflation, at the expense of everyone else. We’ll explain more below.
Cantillon Effect
Consider a hypothetical, simplified economy. Let’s suppose that the supply of money in this economy is fixed, and prices are stable. Suppose that everyday 1000 loaves of bread are sold, at $1 each. Now suppose some member of the community decides that it’s easier to produce counterfeit currency than to earn an honest living. He prints up $100, and uses it to buy bread.
The supply of bread (and all other real goods) has not changed.[3] Furthermore, the rest of the people in the economy still want to buy the same amount of bread. So what will happen?
There is now more bread demanded at $1 per loaf than is available for sale at that price. So the price of bread will rise until some people who would have bought it at $1 per loaf no longer buy it.
Now the bakers will have more money. The bakers will use some or all of this extra money to buy more things they want. That will increase demand for those goods, but supply of those goods has not changed. The prices of those goods will rise. The sellers of those goods will have a bit more money, and they will buy things, driving up those other prices, and so on.
Many prices will rise, but some will rise more than others. Some prices may even fall.[4] The price of bread will rise first. Some people will adjust their behavior, because the increased price of bread sends the signal that bread has become relatively more valuable. There is no way for producers (or anyone else, including government economists) to distinguish between a real change in people’s desires (demand) and the artificial demand created by the counterfeiter.
Some production effort will be switched away from other products, say cheese, to make more bread. But there has not been a real reduction in the demand for cheese. (People want just as much cheese as ever before, but producers are switching to make bread instead because bread commands a relatively higher price.) So when less cheese is produced, there is less supply, and the price of cheese will rise.
These kind of effects ripple through the economy, creating many losers, and — other than the counterfeiter and some who get the new money early — few, if any, winners.
If an economist were measuring the “price level,” in this economy, he would see that the price level had risen. He would say there was inflation.
In our example, the baker, at first, might be better off, because he was able to sell his bread for more. But in fact, the total amount of real goods in the economy is the same as before the counterfeiter printed the counterfeit money. So each dollar cannot buy as much as it could before the counterfeiter printed the extra money.
The higher bread price will draw in more bread production, bringing the price of bread back down, though probably not all the way back down to $1. After the initial increase in bread demand works its way through the economy, the baker will now be worse off. He’s worse off because the price of bread came back down; his extra profits will get smaller, or go away completely. Furthermore, because the prices of many other goods will have risen, the money he does earn will not buy as much as it did before the inflation.
The economic process that occurs when governments create money out of thin air is essentially the same. The rise in the “general price level” is seen, and reported as inflation. But the distortions in the market are harder to see, and may be invisible to most people. Nevertheless, most people are hurt, because they did not get the “free” money, or did not get it early enough. A select few people may benefit, especially if they receive a large windfall of money at the beginning.
The Economic Difference Between Printing Money and Borrowing Money
As demonstrated by the video, Bernstein seems not to understand – or perhaps not care – what difference it makes if the government prints money, or borrows it.
There are a lot of differences, and we’ll focus only on one main difference, and it’s extremely simple: borrowing is not directly inflationary.
Government borrowing is not directly inflationary the way printing money (or creating it electronically) necessarily is.
Inflation is caused by excess growth in the money supply. When the government prints money to pay for its spending, everything else equal, that is necessarily inflationary.
However, when the government borrows money, it is possible that the overall level of the money supply doesn’t change at all – for example under a true gold standard– that the government could pay off its loans without creating more money in the money supply. In fact, that it constraint on government printing money is the primary reason that governments around the world abandonded the gold standard. For modern governments, inflation is a feature, not a bug, of being able to print money.
Here is one way to see why printing money, though, is necessarily inflationary. We can look at the equation of exchange:
- MV = PQ[5]
In this equation, the left side represents the money supply. M is the stock of money and V is the velocity or the demand for cash balances. On the right side, P is the “price level” and Q is the total quantity of goods and service.
When the government prints money to buy goods and services, that printing does nothing to increase the quantity of goods and services. In the equation, Q is fixed.
But M – the stock of money – increases by the amount that the government prints. So when the government prints money and spends it, everything else equal, the left side of the equation must increase.
In an equation both sides must be equal. When the left side increases, by definition the right side must also. And because Q doesn’t increase, P must increase. P is the price level. An increasing price level is inflation.
(For a more complete explanation of the process, click here to request our book chapter explaining the economics of inflation.)
[1] It is presumed that most illegal counterfeiting is done by printing actual currency. But we would not be surprised if there is undiscovered electronic counterfeiting – i.e. the creation by hackers of bank balances without actually depositing money into the bank.
[2] Essay on the Nature of Trade in General, written in French in 1730 and first published in 1755 in French. English translation by Henry Higgs, https://www.econlib.org/library/NPDBooks/Cantillon/cntNT.html.
[3] Actually, the supply of real good would be smaller than before, because the counterfeiter no longer produces real goods. But we ignore that here for simplicity. In the real world, the so-called deadweight costs of government are huge.
[4] The basic idea is that after the counterfeiter introduces the new money, all other consumers are, in effect, poorer. They are poorer because the price of bread has risen. The micro-economic term for this relative impoverishment is the income effect. Because consumers are poorer, they must reduce consumption of at least one good. It is possible that this income effect will result in some prices actually falling.
[5] This expression is believed to have been first formalized this way by the American economist Irving Fisher. See, e.g., https://www.econlib.org/library/Enc/bios/Fisher.html
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