Answer to Question #225093 in Macroeconomics for Sara

Question

What happens when the Fed monetizes a budget deficit? Is this something it should always
try to do? (Hint: Outline the benefits and costs of such a policy over time.)

Answer 1

A budget def it occurs when expenses exceed revenue and indicates the financial health of a country.

When the government deficits are financed through debt monetization, there will be an increase in the monetary base which causes the aggregate demand curve to shift to the right leading to arise in the price level. This is not something that we should always do because it's prohibited in many countries because it's considered as dangerous due to the risks of creating runaway inflation.

The costs of it is that;

Frequent or excessive dependence of a country on debt can hamper economic growth of a country in the long term.

When the government borrows, they will pay the loan in addition of interest which drives up the government expenditure in subsequent periods and also increases deficits in the future.