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I have 2 related questions about increasing money supply: (I know high school level economics.)

1) In an economy which has low growth and deflation, is it at all a bad thing to print money? In fact, wouldn't printing money mean that the government could pay for extra public services that another government cannot afford, which seems like a very good thing in these days of austerity measures?

2) Quantitative Easing is sometimes called "printing money". As I understand it, the central bank buys government bonds, but as I read goverments get back a lot of central bank profits (i.e. the interest on those bonds), and also governments occasionally grab a lump sum from the central bank (e.g. UK 2012). Therefore the debt from QE doesn't sound like real debt, and instead it seems to amount to the government printing money. So why is QE reported in the press as a bad thing in the EU and Japan? (I.e. is it not a golden opportunity to boost public services and bring people into work, while inflation is not a concern?)

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  • $\begingroup$ Your premise is wrong. Only people who know very little about Economics, Macroeconomists who don’t understand the Fisher equation (or have trained at Minnesota…) think that QE is bad when the economy is at the Zero Lower Bound. Read this: modeledbehavior.com/2011/09/16/immaculate-inflation $\endgroup$ – fni Jan 24 '15 at 7:03
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1) In an economy which has low growth and deflation, is it at all a bad thing to print money? In fact, wouldn't printing money mean that the government could pay for extra public services that another government cannot afford, which seems like a very good thing in these days of austerity measures?

The Central Bank can’t finance Government expenditure in almost all the developed western Countries, so this doesn’t seem to be the main channel through which Monetary policy works.

So why is QE reported in the press as a bad thing in the EU and Japan?

It depends on which kind of press do you read...

Here the ECB tries to explain how they think Monetary Policy works. There are four main channels trough which Monetary Policy works:

  1. Interest rates: in the traditional Keynesian IS-LM tradition lower interest rates boost Investments and then output. The more recent New Keynesian view is that they change the trade-off consumers face between consumption today and consumption tomorrow (basically, it’s another more convoluted way to say they have an incentive to invest…)
  2. Asset Prices: the price of assets, being a discounted expected value, mechanically increase when interest rates decrease (i.e. the discount factor gets closer to one). This means aggregate wealth increase and people have an incentive to consume/invest. A similar channel involves Tobin’s q (i.e. the ratio between the market value of capital and its replacement value): when Tobin’s q is higher firms can invest a lot with very little equity.
  3. Credit: it mainly works through bank lending and the balance sheet of firms. One way or another, monetary policy increases banks’ deposits or banks’ debt which should be reflected on the asset side of the bank: hence more loans. Moreover, expansionary monetary policy increases the net worth of firms making easier for them to obtain loans (in the end firms net worth works as “collateral” for banks’ loans (see Bernanke&Gertler (1989)).
  4. Exchange Rates: see the Euro in these days. QE lower exchange rates and should boost exports. Of course, while everybody can use the previous channels contemporaneously, not all the Central Banks of the World can contemporaneously work on the exchange rate.

This paper by Mishkin may be a useful review.

All in all, does monetary policy work? I don’t know, but if you look at Europe and at the United States you have a “natural experiment” to answer your question...

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  • $\begingroup$ Thanks. That paper by Mishkin and your summary are interesting reading. But I don't get your very first point: if the central bank buys government bonds and then gives back some of its profits to the government or allows the gov to take some of its assets, then how is it not financing gov expenditure? (economist.com/blogs/freeexchange/2012/11/monetary-policy-4) $\endgroup$ – snoopy Jan 24 '15 at 16:09

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