What Are the Best Tips for Deficit Financing?

The currency financing law refers to a method in which the government borrows or overdrafts from the central bank, that is, by directly increasing the amount of money to make up for the fiscal deficit. In essence, it monetizes the fiscal deficit.

Money Financing Act

Right!

Monetary financing law refers to the government's

Money financing law has three manifestations:

First, the central bank directly purchases

Monetary Financing Law Makes up the Impact of Fiscal Deficit on Inflation

The currency financing method is to make up for the deficit through the issuance of high-energy currencies by the central bank, which will undoubtedly result in the monetization of fiscal deficits. This is divided into two types of situations: through the bank or using the market:

First, the Ministry of Finance made up for the impact of fiscal deficits on inflation through direct overdrafts with the central bank and direct purchases of government bonds by the central bank.

Most of the countries that adopted overdrafts to make up for the deficit were countries that had previously implemented planned economic systems. Because in these countries, finance and banks are not directly separated from each other and are funds that the government can directly dispose of. The countries that adopt a market economy system to make up for the fiscal deficit by purchasing the government bonds directly from the central bank. Generally speaking, the use of overdrafts to make up for the fiscal deficit and the direct purchase of government bonds by the central bank to make up for the fiscal deficit will lead to an increase in the amount of money in circulation. If the production of goods and services cannot be matched with the increase in the amount of money in the short term, Inflation will occur in economic development.

Second, in countries with market economy systems, another way to make up for the deficit is through the open market operations of the central bank.

The central bank buys bonds issued by the government to the public in the open market. What will happen? The central bank buys public bonds in the open market and the money supply increases. In this sense, whether open market operations will lead to monetization of the deficit depends on the monetary policy of the central bank.

Take the US Federal Reserve Bank as an example: For a long time, the Federal Reserve has implemented a monetary policy of maintaining the target nominal interest rate. When the government issues public debt to make up for the deficit, the level of interest rates rises due to the increased demand for borrowing from the entire society. High interest rates will have a crowding-out effect on non-government investment, thereby weakening the effects of expansionary fiscal policy. Therefore, the target interest rate needs to be maintained, and the Federal Reserve purchases government bonds in the open market to expand the money supply, so that the interest rates that are raised by the government's issuance of public debt will fall back to the target interest rate level. However, since the 1980s, in order to overcome the problem of stagflation, the Fed replaced the interest rate target policy with a strict monetary target policy. The method of making up the fiscal deficit of the additional currency implies the crisis of inflation. It can be seen that the open market business as a way to make up for the deficit, whether it can lead to inflation, also depends on the central bank's monetary policy.

Impact of Monetary Financing Law on the Economy

The Monetary Financing Law through the central bank's additional high-energy currency to make up for the deficit will increase the entire money supply and reduce or maintain the original interest rate level. On the one hand, it will increase government purchase expenditure, and on the other hand, it will not crowd out non-governmental sector investment and consumption. As a result, total social demand has risen. If the government's deficit fiscal policy is designed to increase the effective demand of society, the currency financing method can be adopted.