Economics Behind Printing of Currency
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Economics Club IIT Delhi
Jan 16, 2015, 12:11:27 PM1/16/15
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One of the fundamental equations in money supply is:
MV = PQ = GDP
M = Money Supply
V = Velocity of Money - how many times a dollar gets circulated
P = Average Price of goods produced in an economy in a year
Q = Total amount of goods produced in a year
How Monetary Policy works?
We can intuitively understand that, GDP is the measure of the worth of all goods produced in a year and shown as PQ. On the left side, GDP is the total money spent (indicated by how much money is multiplied by how often it is spent).
The Central bank in a country will look at all the three variables (V, P, Q) before deciding on how much M (money supply has to be) has to be. How can the other variables change:
P (price) can change when there is inflation caused by shortages or excess money supply. When that happens, Central banks reduce M on the left to balance. In India, Reserve Bank is reducing money supply as P is going up.
Q (Quantity) can change with productivity levels or increased supply in factories. When this happens, Central banks increase money supply so that there is no major impact on P or V.
V (Velocity) can change when people get really afraid to spend. If everyone keeps their money under their mattress, V goes to zero and so does the GDP. Thus, Central banks will try hard to increase Money supply. This is what happening in the US now.
Although people use "printing money" in a colloquial sense, US government/Federal Reserve doesn't literally print money to increase money supply.
During Fiscal Year (FY) 2012, the Bureau of Engraving and Printing delivered approximately 35 million notes a day with a face value of approximately $1.5 billion.
That is less than $500 billion annually or 3% of US GDP. Most of this printing is to replace damaged notes. Thus, printing physical currency is primarily a convenience thing. The real money supply is controlled by how banks lend money. Money supply can be decreased and increased by how banks borrow & lend money.
MV = PQ = GDP
M = Money Supply
V = Velocity of Money - how many times a dollar gets circulated
P = Average Price of goods produced in an economy in a year
Q = Total amount of goods produced in a year
How Monetary Policy works?
We can intuitively understand that, GDP is the measure of the worth of all goods produced in a year and shown as PQ. On the left side, GDP is the total money spent (indicated by how much money is multiplied by how often it is spent).
The Central bank in a country will look at all the three variables (V, P, Q) before deciding on how much M (money supply has to be) has to be. How can the other variables change:
P (price) can change when there is inflation caused by shortages or excess money supply. When that happens, Central banks reduce M on the left to balance. In India, Reserve Bank is reducing money supply as P is going up.
Q (Quantity) can change with productivity levels or increased supply in factories. When this happens, Central banks increase money supply so that there is no major impact on P or V.
V (Velocity) can change when people get really afraid to spend. If everyone keeps their money under their mattress, V goes to zero and so does the GDP. Thus, Central banks will try hard to increase Money supply. This is what happening in the US now.
Although people use "printing money" in a colloquial sense, US government/Federal Reserve doesn't literally print money to increase money supply.
During Fiscal Year (FY) 2012, the Bureau of Engraving and Printing delivered approximately 35 million notes a day with a face value of approximately $1.5 billion.
That is less than $500 billion annually or 3% of US GDP. Most of this printing is to replace damaged notes. Thus, printing physical currency is primarily a convenience thing. The real money supply is controlled by how banks lend money. Money supply can be decreased and increased by how banks borrow & lend money.
Regards,
The Economics Club Team
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