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 - 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.
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