Economics Department
Econ 202
Binh Nguyen


Because the Government has to pay its bills just as we do, it has a budget constraint. There are three sources to finance the government's expenditures: taxing, borrowing or printing money. In many countries, when the government expenditures excess the tax revenue (the Government budget deficit occurs) they can not finance the deficit by borrowing (issuing bonds) and must resort to printing money. At a result, when they run large deficit relative to GDP, the money supply grows at substaintial rates, and inflation results.

In the United States, however, the government does not have the right to issue currency to pay for its bills. In this case, the government must finance its deficit by first issuing bonds to the public to acquire the extra funds to pay its bills. Yet if these bonds do not end up in the hand of public, the only alternative is that they are purchased by central bank. It leads to an increase in monetary base and in the money supply. This method of financing government spending is called monetizing the debt .

Finacing a persitent deficit by money creation will lead to a sustained inflation. An critical element in this process is that the deficit is persitent. If temporary, it would not procedure an inflation. The one-shot increase in the money supply from the temporary deficit generates only a one-shot increase in the price level, and no inflation develops.

How much does the United States resort to the printing press to raise the revenues to pay for government expenditures. The increase in the monetary base is a measure of the amount of government revenue that is raised each year through the printing rather than through taxes or borrowing. In 1995 the monetary base increased by $17 billion. Compared with the $1,519 billion of government expenditures during 1995, this is a trivial amount: only about one percent of government expenditures were financed by printing press in 1995. This small percentage is typical in recent U.S. history. Hence, the printing press are not a very important sourse of revenue for the United States in the morden time. But this was not always true. About 80% of America Revolutionary War expenditures were financed by printing paper money, called "continental". So much money was printed that a serious inflation occured : prices rose by over 300% from 1776 to 1778 and 1,000% from 1778 to 1780; hence the phrase " not worth a continental". The printing press set off even worse inflations in Germany and several European countries in the 1920s and in Argentina, Brazil, and other South American countries inthe 1970s and 1980s.