When a central bank purchases the bonds of its country to ease stress on the government's...

When a central bank purchases the bonds of its country to ease stress on the government's budget, this is known as _____ and can lead to _____.

Monetizing the debt; inflation
Fiscal policy tightening; inflation
Monetizing the debt; currency appreciation
Fiscal policy tightening; currency appreciation

Solutions

Expert Solution

ANSWER : a. Monetizing the debt; inflation

Central bank influences the interest rate. They use open market operations to achieve their targets and to achieve price stability. Open market operations are the buying and selling of bonds in the economy to increase or decrease the money supply in the economy. The central bank purchases the government bonds and keep interest rates low and monetize the debt.

Debt monetization is the process where central bank purchases government bonds through open market operations. This increases the monetary bases through money creation. Debt monetization is used to finance the government budget deficit, it leads to increase in the monetary base. As a result the aggregate demand increases in the economy and thus increase in price level. This causes inflation in the economy.

Rahul Sunny answered 1 year ago

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