When deciding whether or not to monetize a deficit, a central bank faces a dilemma, since if it decides
A)not to finance the deficit, higher interest rates may lead to the crowding out of private spending
B) not to finance the deficit, the domestic currency may depreciate and balance of payments problems may result
C) to finance the deficit, excessive monetary growth may lead to inflation
D)to finance the deficit, interest rates may increase too much
E)both A)and C)

Question

Quizplus · Accepted Answer

If the central bank chooses not to finance the deficit, higher interest rates may discourage private spending, which can lead to a decrease in economic activity and potentially harm the economy. Additionally, if the deficit is not financed, the government may have to cut spending, which can also harm the economy.

On the other hand, financing the deficit by monetizing it can lead to excessive monetary growth, causing inflation. This can lead to a decrease in the value of the currency and a loss of confidence in the government and the central bank.

Therefore, the best choice is to find a balance between financing the deficit and ensuring that the monetary growth does not lead to inflationary pressures. The central bank can do this by carefully managing the money supply and interest rates.

When Deciding Whether or Not to Monetize a Deficit, a Central