Principle 9: Prices Rise When The Government Prints Too Much Money

What is Price Rise When the Government Prints too Much Money”?

“Prices rise when the government prints too much money” is the ninth principle of the ten famous principles of economics given by the eminent macroeconomist N. Gregory Mankiw. He gave us these principles in his book “Principles of Economics.” This principle explains to us how printing too much money by the government results in inflation and price rise in an economy.

What is Inflation?

Inflation is the persistent and considerable rise in prices of goods and services in an economy over a period of time. We do not call a price rise that occurs once or twice over a time period inflation. It should be persistent, and prices should show an upward trend during that period.

Also, it should be considerable enough to be called inflation. A mere price rise of 1% or 2% over a period of time is not known as inflation. We have several instances in the past when prices have risen by over 15%-20% and even doubled over a period of a few months. Such a price rise is inflation.

How do the Prices Rise When the Government Prints too Much Money?

It is a common misconception that any government can print more money, hand it over to its citizens and witness exemplary economic growth. This is not true.

Printing more money and dumping it into the economy results in more disposable cash in the hands of the people. The money circulation in the economy rises. Individuals start spending more on goods and services because they now have more money. The overall demand in the economy shoots up because of the increased money flow. Higher demand for goods and services results in higher production. And higher production does result in higher employment generation as well. So, where does the problem arise?

Production levels have a constraint. We can increase the production of goods and services in a limited manner in a short span of time. There are resource constraints such as a limited supply of labor, machinery, capital, etc. These constraints do not allow us to increase the supply significantly.

Mismatch in Demand and Supply

The prices start rising with an increase in demand in the economy. This is because of the simple law of demand and supply. An increase in demand without a matching increase in the supply of goods results in rising in the price of that good. A product that was of $10 is now priced at $12. This happens with almost all the goods and services in the economy. In reality, the purchasing power of money has gone down. We need more money now to buy the same quantity of goods that we used to buy earlier. In other words, we have to pay more for our consumption basket.

Suppose the government decides to print more money to cater to the rise in demand for its currency in the economy. This action creates a spiral-like situation. The demand increases again, supply is the same, and thus the prices also shoot up. It results in inflation in the economy. The value of the currency goes down further. We need even more money now to buy any product or service. Now the product, which was of $10 in the first instance, costs us $15. Therefore, the printing of more money without a supporting increase in economic output gives birth to inflation in the economy.

Summary

A famous economist once said- “Inflation is caused by too much money chasing after too few goods.” Printing too much money without a supportive increase in the supply side results in inflation.

Every economic policymaker in the world aims to keep inflation under control. Inflation does more evil than good to society. A high rate of inflation has a damaging effect on any economy. It erodes the purchasing power of money, and the people suffer. Persistent inflation leads to a fall in the actual consumption of goods and services in the long run, as people cannot afford to buy more with their limited incomes. Their consumption basket shrinks. This is the reason why it becomes necessary for governments to exercise caution and control while printing money.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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