There is a common conception, a common metaphor, held by many people that the government has the ability to print money. Along with this conception also goes the view that such money printing, necessarily, would be a cause of inflation and that the government - because of this - rarely, if ever, actually chooses to print money. The views associated with the common conception are false on both counts.
Firstly, it is important to note that the common conception we are referring to really is just a metaphor: most money is electronically created, with no use of a physical printing press. A better phrase would be to say that the government "issues" money, as the economist Bill Mitchell has repeatedly pointed out.
In any case, the common metaphor maintains that the government very rarely issues money, perhaps occasionally - a frequent example is the money printing of the Bank of England or Federal Reserve's Quantitative Easing programs, used sparingly and only in supposed emergency.
This picture does not hold up, however, if we enquire into the nature of money. As has been emphasized by various specialists, money is essentially an IOU - government money is a government IOU, bank money is a bank IOU, and so on. This has always been the case, prompting the British historian, Alfred Mitchell-Innes, to conclude at the end of his survey of the history of money that "money, then, is credit and nothing but credit."
Thus, whenever the government prints or issues money, it is printing or issuing IOUs. Whenever it taxes or borrows, it is recalling its IOUs. From the logic of IOUs, it follows that taxation and borrowing destroy money - as an IOU that has been returned to its issuer is no longer an IOU. This is why it is inaccurate to describe taxation and borrowing as ways to fund government spending; taxation and borrowing void money by removing the IOU from circulation. This naturally leads to the question, how does the government actually fund its expenditure, if not through taxation or borrowing? In answering this question, we shall be able to eliminate one of the misconceptions of money.
The government is able to spend, because whenever it spends it issues new money. In terms of the common metaphor, whenever the government spends, it (electronically) prints the required money. Again, this just follows from the logic of IOUs - if you are the issuer of the IOU, then in order to spend or give them away, you must first create and issue new IOUs. We can conclude, then, that the government must print/issue money every day in order to meet its spending commitments. This should not be a contentious point as it follows as a matter of logic.
Now, the operational details - in the UK's case: the British Treasury account at the Bank of England receives taxation and borrowed money - may appear to show that taxed money is used to fund spending, but this is a superficial, arbitrary detail. As soon as taxation is collected, it ceases to be money, but a kind of trace is left over on government records. This accounting trace is then transferred into the Treasury account and then becomes a new IOU, renewed money. It would be essentially the same story if the government deleted the tax receipts and then printed the exact amount a few minutes later, though this would be pointless.
To emphasize this point, we need only recall that the government cannot, in a literal sense, owe itself its own money. This means that when the government receives tax, that money has no one to which it is owed - there is no "U" in the "IOU."
The second misconception is perhaps the more difficult misconception to rid ourselves of - the idea that printing money is inflationary. To show this, we must recall what inflation is. Inflation is a consistent rise in prices, which is caused by nominal demand exceeding the output of the economy. That is, if the demand for some goods (measured in nominal terms) is greater than the capacity of the economy to produce new goods, then an inflationary episode will occur. This actually allows for the possibility that the government might deficit spend (thereby increasing nominal demand) and if the economy responds appropriately (builds enough goods), prices might decrease. As the economist Wayne Godley noted, "prices can actually fall when the money supply increases."
Now, the sceptics of government budget deficits often point to examples such as Weimar Germany and Zimbabwe, to prove that printing money causes inflation. However, both of these situations were instances of contracting supply - namely, economic output in both cases dropped substantially. This caused nominal demand to rise above the capacity of the economy to produce new goods, causing massive inflation. Note, however, that this was not caused by the printing of money, but by contracting economic output.
Furthermore, since inflation depends upon nominal demand, it follows that printing money by itself will not create any inflation. This is because newly created money does not automatically contribute to nominal demand - it might, for instance, be put into savings or stuffed under a mattress.
It is quite clear, then, that - following the logic of an IOU - printing money is neither necessarily inflationary nor something the government rarely does. Rather, due to the nature of money, printing money is a common occurrence, happening on a daily basis as the government decides to spend. Understanding these points will help us realise the utility of money, potentially achieving full employment and price stability.