Question

What does it mean to monetize the deficit and why is it especially inflationary? Thanks! (Macroeconomics)

Answer 1

Concept of Monetize the deficit was popularised by the Keynes. During the recession, there is sharp fall in aggregate demand in economy. Government has to make intervention to correct or prevent fall in economic activities. Thus, When government increases its expenditure , it should not resort to the borrowing , instead government must go for printing new currency. Printing of new money is called monetization of deficit. it increases demand without causing crowding out effect. So, demand will rise significantly, if there is no enough production capacity, demand will substantially get converted into inflation.

Government should not go for monetization of deficit during boom period, else there will be massive rise in inflationary pressure,. Monetization of deficit can be followed when economy faces huge recession or depression. It must be chosen carefully,