Question

Why do governments sometimes pay for their spending by printing more money? Why do economists refer to this as an ‘inflation tax” that can result in very harmful results?

Answer 1

Answer - The government sometimes pay for the spending by printing more money. This is called deficit fianancing. In many cases , the government does not have the adequate tax revenues , it may have the limited capacity and resources to borrow. In such situations , to finance the spending , the government has to print more currency.

This is called the inflation tax. This is because the printing of money has a negative impact upon the economy. By printing the money , the money supply in the economy increases , leading to inflation. The money with people increase ans hence the value of money declines. This has to be paid in form of increased taxes.