Why can’t the central bank print unlimited currency?

With the Covid-19 crisis, the entire nation is clutched in the tentacles of the deadly virus. Companies are laying off their employees, migrant laborers are forced to take shed back again in their hometown, and health infrastructure is completely shattered. With no sign of virus shoving off, sustaining without active income is proving to be a tough nut to crack for most of the population in India.

Indeed, it is on the Government of India to step out of comfort and pull the nation out of the Covid crisis. But how? With major sources of revenues curbed as a result of lockdown, the government is certainly in a tough spot in clearing all alone. Reserve Bank of India (RBI) comes to rescue the government out of this crisis, as a ‘lender of last resort,’ by ‘Monetizing the deficit’.

Pitfalls in printing money :

RBI printing money for the government to meet what it needs seems like a perfect solution to the crisis, but it is NOT! No central bank will want to print new currency to help the government meet its expenditure, because such an act might lead to ‘Inflation’ or in extreme situations ‘Hyperinflation’.

When a country tries to get rich by printing more money, it fails to achieve so, as prices go up and people get stuck in a spiral where they need more and more money to finance their needs. So technically, as the supply of currency drastically increases, everyone gets hang of an abundant amount of currency, but as the supply of goods and services is constant, their prices go up, leading to inflation.

In past, there exist many countries which opted for printing more currency to build their economy and stand out among the best-developed countries, however they failed gravely. One such country is Zimbabwe, which was hit by the worst hyperinflation world ever experienced in 2008, within a single year prices rose as much as 231,150,889%. (A packet of bread that once cost one Zimbabwe dollar, was worth 231 million Zimbabwean dollars a year later.)

The Gold Parity System

With the end of WWI, by 1928, the Central bank’s gold reserves were augmented with currencies that could be converted into gold at a stable rate of exchange. Nonetheless, the Great Depression of the 1930s marked the collapse of the gold exchange standard. After World War II, the world needed a new exchange rate system, the gold standard was well-thought-out to be too rigid.

Therefore, on 1 July 1944, 44 countries sent their delegates to Bretton Woods, New Hampshire with the principal goal of coming up with a new efficient exchange rate system, prevent countries from devaluing their currency to raise exports, and facilitating international economic growth. It was decided to peg the US dollar to the value of the gold, and further, all other currencies were then pegged to the US dollar.

Unfortunately, Bretton Wood’s System didn’t survive, because the US kept running deficits to fund various projects which lead to a tremendous rise in the number of dollars in circulation, and a steep fall in gold reserves in the US. therefore on 15th august 1971, President Richard M. Nixon officially announced that dollars would no longer be convertible to gold.

With the formulation of International Monetary Funds (IMF) in 1946, the Gold Parity Standard came into being, which is a modern version of the international gold standard. Under this system, every subsequent IMF member country has to ‘define the par value of its currency in terms of gold,’ which helps in determining their exchange rates for international transactions.

Photo by Pixabay on Pexels.com
Picturing things in present times..

The main advantage of the Gold Parity standard is that it helps in maintaining a stable exchange rate without an outlaying gold status of the monetary standard. Therefore, aiding inefficient working of the exchange rate flexibility without disturbing the domestic monetary system of the member countries. Indeed, member nations can follow an independent monetary policy within this system.

Today the currency that is issued by RBI depends upon the reserves that RBI has after meeting its all liabilities. To issue new currencies, RBI needs to follow the Minimum Reserve System (since 1956), whereby RBI needs to maintain a minimum reserve of Rs 200 crores, out of which Rs 115 crore should be kept in the form of gold coins and gold bullion, and rest as foreign currencies.

The main objective of this system is to lay down rules and principles for RBI to follow while issuing the new currencies, which aggregate with economic growth, transaction needs, and people’s well-being. Presently, even though RBI maintains minimum reserves of gold, the value of rupees is not defined by gold, its value only depends on purchasing power which inversely relates to the price level in the domestic country. __________________

References: https://en.wikipedia.org/wiki/Bretton_Woods_system https://www.imf.org/external/about/histend.htm https://www.preservearticles.com/economics/what-are-the-main-features-of-gold-parity-standard/12040

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