Answer to Question #90087 in Macroeconomics for marwan essam

Question #90087
In a monetary policy , among other ways to finance a deficit – there are :
Issuing securities, Fiat money, Borrowing from abroad, or Borrowing from domestic financial institutions.
Elaborate – verbally and graphically on 2 methods:
One method leads to inflationary pressure, and another method leads to a negative impact on investment – through interest rate
1
Expert's answer
2019-05-27T11:57:03-0400
  1. Emission method of financing the state budget deficit. This method consists in the fact that the state (the Central Bank) increases the money supply, i.e. It puts into circulation additional money, with the help of which it covers the excess of its expenses over income. The main disadvantage of the emission method of financing the state budget deficit is that in the long run, an increase in the money supply leads to inflation, i.e. This is an inflationary mode of financing.
  2. Financing the state budget deficit through domestic debt. This method consists in the fact that the state issues securities (government bonds and treasury bills), sells them to the population (households and firms) and uses the funds received to finance the excess of government spending over income. A significant drawback of the debt financing method is the “crowding out” of private investment. The economic mechanism of the “crowding out” effect is the following: an increase in the number of government bonds leads to an increase in the supply of bonds on the securities market. The increase in the supply of bonds leads to a decrease in their market price, and the price of a bond is inversely related to the interest rate, therefore, the interest rate increases. The increase in interest rates leads to a reduction in private investment and a decrease in output.

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