As you would expect from the largest economic collapse in 80 years, the global financial crisis shook many of the basic principles of macroeconomics and left a lot of respected economists looking quite silly. But nothing seems more puzzling than the curious absence of inflation.

When the central banks of the developed world began printing money to soften the blow of the recession, most people were expecting inflation to rise. Some were even warning of hyperinflation. Investors piled into gold, thought to be an inflation-proof investment, and produced a boom and a subsequent bust in the price of gold.

That money printing should cause inflation is very intuitive and is also supported by plenty of historical evidence. With more money chasing the same amount of tangible, real goods, it seems obvious that prices should rise. Throughout history, hyperinflation was a common feature of failing economies, whether it was due to medieval kings resorting to money printing to fund military adventures, Weimar Germany printing to pay war reparations or, more recently, Zimbabwe turning on the printing press to finance the Mugabe regime [1].

But just as you can’t use Newtonian physics to explain the movement of objects as large as planets and stars, it seems that many macroeconomic theories cease to apply to the complex modern world economy. Despite printing money on an unprecedented scale combined with interest rates being lower than ever (also thought to be an inflation-inducing piece of monetary policy), inflation remains extremely low, almost non-existent in all of the world’s major developed economies.

So far, central banks have been relatively conservative in structuring money-printing mainly as a purchase of government bonds. Governments now pay interest to the central banks on the bonds they hold, and given that bonds have maturity dates, there is at least a pretense that the governments will eventually repay to the central banks the money borrowed, reversing the effects of the money-printing. Government accountants have booked the money received from central banks as debt, not as income, meaning that it cannot be used to make government finances look better by reducing the deficit.

But if money-printing doesn’t seem to have any major downsides, why not double down? Why shouldn’t central banks just hand over money to the government, without any expectation of repayment? In Britain for example, £375 billion was printed over the 8 years since the crisis. People tend to skip over numbers when they start to have too many zeroes, but this is an enormous amount. By repeating this, we could increase both the healthcare and education budgets by 20%. Or build 1,500,000 council homes [2].

Intuitively, I feel we should be cautious. A stable, secure currency that is a reliable store of value and a trusted means of exchange is absolutely key to any modern economy. Destroying confidence in the national currency would be disastrous. It also feels difficult to believe that we have found the magic money tree – a license to raise huge amounts of money that doesn’t come from taxpayers and doesn’t need to be repaid.

Monetary policy has been a fringe topic in political life so far. It is far too arcane to make good media headlines. The independence of central banks also been a fundamental tenet of modern market economies, well-respected by mainstream parties. However, with populists of both left-wing and right-wing persuasion on the rise across the world, it is only a matter of time before goverments will try to dip into the central banks’ treasure chests [3]. When politicians smell money, they will try to get their hands on it.

Central bankers need to manage this risk. They might be inclined to believe that their mandate compels them to act as technocrats, operating indepedently of the pressures of politics and public opinion. This would be foolish. Central banks have no manpower. They do not control the police or the military. If they cannot come up with a compelling reason why money-printing is not a valid source of income to the government, politicians hungry for power and oblivious to long-term risks will raid their coffers to the tune of hundreds of billions or even trillions of dollars.

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1. “The African state printed trillions of Zimbabwe dollars in February 2006 in order to buy foreign currencies and pay off the country’s loans to the IMF. The central bank repeated the trick three months later, this time in order to finance massive increases in wages of soldiers, policemen and civil servants. Inflation went through the roof, despite Mugabe’s decision to declare it “illegal”.”

http://www.telegraph.co.uk/finance/economics/8135039/Inflation-History-shows-weve-got-it-easy.html

2. In the US, the Fed bought about $2.5 trillion of government debt over 8 years. That’s the equivalent of a 25% increase in federal health & education spending (or 1.5x Iraq wars).

3. A Jeremy Corbyn government is pretty scary in its own right, but with an independent central bank, his spending ambitions would be limited to whatever he can raise in taxes + borrow from investors. But give him control of Bank of England and he can raise unemployment benefits to £1m per week per person.

For readers unfamiliar with British politics, take Bernie Sanders and assume every Republican scare story is 100% true. That’s Corbyn.