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Sustento Institute
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Money and Inflation
25 November 2011
New Zealand government gross debt is at $72.4bln and is set to hit $90bln in 2016, according to Treasury forecasts. That’s likely to be costing the taxpayer $4-5bln a year depending on where bond yields are. They are at record lows now but if we see another credit crunch, they may rise quickly. The question needs to be asked, why doesn’t the government simply create the extra money it needs and spend it directly into the economy?
Governments incur budget deficits when the money they raise through taxation doesn’t cover their spending plans. It’s the same as a household spending more than it earns. In tough times tax receipts fall yet spending often remains at the same level, causing a shortfall.
The current expenditure requirement for the Christchurch redevelopment is an example of this. The government plans to borrow $5bln for this but I would ask why? Why doesn’t it simply print the money itself and spend it into circulation?
The answer you will get to this question is: its will be inflationary. However, that is not automatically the case. Generally speaking, if the money supply is increased, that will cause prices to rise. That is not a completely accurate statement, as it depends on other variables in the economy. If there are enough resources and labour available at current prices, then new expenditure will not be inflationary.
Manufacturing capacity is currently well below maximum levels and labour is available, so there are no concerns that this new money will create inflation in the real economy. That is one side of the equation. The other is that the new money will enter the banking system as new deposits and so potentially provide the banks with new assets on which to lend.
Currently that is not a major issue, as demand for new credit is stagnant and has been for 3 years now. Also with the global debt deleveraging process continuing, new credit is being offset by debt repayments and write offs, thus keeping the money supply stable. One policy available to the government is to raise capital ratios from the banks, forcing them to keep higher amounts of capital in reserve, and thus limiting their ability to create new credit and expand the money supply to the point where it will create price rises.
So the government could print new money and spend it directly into circulation, thus saving the taxpayer between $200-250m a year in interest. Why wouldn’t you want that?
For more on this, listen to Raf Manji’s interview with Kim Hill on Radio National NZ http://podcast.radionz.co.nz/sat/sat-20111112-0810-raf_manji_money_and_the_economy-048.mp3
