Why can't Government print unlimited currency?

By December 12, 2019No Comments

There is common doubt in everyone’s mind that why can’t a government print money and distribute to its citizens. To get this clear

Let’s discuss with an example:-

Suppose there are  only two people residing in a country say XYZ with an income of Rs 10 per annum and the only good produced in the economy is rice.

For example, the total goods and services produced in the country is 2 kg of rice. Now to buy 1 kg of rice, one has to pay Rs.10 per Kg.

Imagine all of a sudden government starts printing moremoney, and the income risesfrom Rs.10 to Rs.20but the supply of rice remains the same as 2 kg.  with more cash in hand, the demandfor rice has gone up, and the price of 1 kg of ricehas increased from Rs.10 to Rs 20.

In both scenarios, the quantity produced hasn’t changed, (2 kg of rice) but the price has been changed sharply (from Rs.10 to Rs.20) due to excess money printing. So printing of money should always match the total production of goods and services in the country or else inflation can destroy the economy.

Major factors to be considered while printing new currency: –

Inflation: –

Inflation is the increase in the prices of goods and services over time. It’s an economics term that means you have to spend more to buy a gallon of milk, fill your gas tank or get a haircut. Inflation increases your cost of living. Inflation reduces the purchasing power of each unit of currency.

Almost a few years back, 3 eggs could have cost you 100 billion dollars “Zimbabwe” bank note. So basically we are talking about a total devaluation of the currency. Of course, this is extreme, but it shows the capability of inflation beast.

Gross Domestic Product: –

GDP is the final value of the goods and services produced within the geographic boundaries of a country during a specified period, normally a year. GDP growth rate is an important indicator of the economic performance of a country. 

GDP is another important factor that affects the amount of money to be printed in the economy. The government prints money of the same value, as the value it has gained into their economy or in a simple way GDP. So,rising economic productivity – GDP increases the value of money in circulation since each unit of currency can subsequently be traded for more valuable goods and services.

The point worth noting is, the government gives people the same amount of physical currency as a medium of exchange as the value it is getting in return from GDP and inflation.

Minimum Reserve System: –

Currency issued in the country is reliant upon the reserves, RBI has with it after meeting all its liabilities.

Now by reserves, it means the following:

            1. Bullion reserves

            2. Foreign exchange reserves

            3. Balance of Payment(BOP) only receivables.

In India, currencies are supplied by the RBI with the backing of bullionreserves,  foreign exchange reserves (foreign currencies) and Balance of payment(only receivables). For the new issue of currencies, the RBI follows Minimum Reserve System at present. The (MRS) Minimum Reserve System is followed since 1956.

Under MRS, the RBI has to keep a minimum reserve of Rs 200 crore comprising of gold bullion and gold coin and foreign currencies. Out of the total Rs 200 crores, Rs115 crore should be in the form of gold bullion or gold coins. The purpose of shifting to MRS was to expand the money supply to meet the needs of increasing transactions in the economy.RBI follows some principle or rule for issuing new currencies based upon economic growth and transaction needs of the people.

Solid and Mutilated note: –

Soiled note means a note which, has become dirty due to usage and also includes a two-piece note pasted together wherein both the pieces presented belong to the same note and form the entire note.

Mutilated banknote is a banknote, of which a portion is missing or which is composed of more than two pieces.

Soiled and mutilated banknotes which are not fit for circulation, are withdrawn from circulation after duly accounting for them in the records of the RBI. These are then burnt in the incinerators provided at the regional offices of the RBI under strict vigilance and supervision of the RBI officials. The accounting of these banknotes makes it possible for the RBI to work out the printing of the new banknotes in order to replace the burnt currency notes. 

 After getting checked with Inflation, GDP, and clearance of old notes, The Issue department, and management department of RBI  will come with an estimate of currency required and put the demand sheet in front of the central government for approval.

Coordination of RBI with GOI: –

RBI discusses with the Government of India with respect to the denomination, designing and security features of the bank notes to be printed in the country and circulated.

The minting of Re.1 currency coins (formerly Re.1 currency notes) and other coins fall within the jurisdiction of the GOI. After getting approval, it will follow up the process of printing and minting.

Methodology to evaluate the need for currency:-

· The projected GDP figure is available from Govt, CMIE, and RBIs own Research Wing (D). (it considers the factors like Inflation and Gdp)

· We know the cash with RBI and Banks -under Note stock account (N).

· Then there is replacement demand due to the destruction of soiled notes (R).

                                    Total Notes to be printed =  D-N +R

In India, a 5% extra will be added to meet the emergency. This will be counter checked from estimates of Regional Offices and Banks and consolidated and checked DCM Central Office, RBI Mumbai

Then denomination wise break up is taken for printing and print order is given to printing presses and printed in 4 quarters and remittances plannedaccordingly, and the entire procedure is monitored by RBI Issue Department.

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