Management Notes

Reference Notes for Management

Governments may end up with a high money growth rate and high inflation as a result of policies designed to

Governments may end up with a high money growth rate and high inflation as a result of policies designed to

  1. Lower unemployment
  2. Finance persistent government budget deficits through money creation rather than by issuing bonds
  3. Redistribute wealth from debtors to creditors
  4. Both ( a) and (b)

Correct Answer: Both (a) and (b) 

 Answer Explanation

By pursuing policies to reduce unemployment or finance persistent government budget deficits, governments may inadvertently promote high money growth and inflation. In option (d), which includes both (a) and (b), the following policy scenarios are correctly identified:

a. Lower unemployment

When a government uses expansionary monetary policies to reduce unemployment, it often increases the money supply and reduces interest rates. Governments aim to stimulate borrowing, spending, and investment by doing so, resulting in economic growth and jobs. When the money supply grows too rapidly, however, it can create an excessive demand for goods and services. A combination of excess demand and supply constraints can cause prices to rise, resulting in inflation.

b. Finance persistent government budget deficits through money creation rather than issuing bonds:

Governments facing budget deficits have a variety of options for covering their budget deficits, including borrowing or creating new money. In order to fund government spending, the central bank effectively prints money to fund deficits. In addition to meeting immediate funding needs, this can also lead to an increase in money supply that is more rapid than economic growth.

Therefore, excess money supply can contribute to inflationary pressures, especially if the growth rate of money exceeds the economy’s production capacity.

Why the other options are not correct

a. Lower unemployment:

It is true that expansionary monetary policy that aims to reduce unemployment can result in high money growth and inflation, but it fails to take into account the inflationary effects of creating new money to finance government budget deficits. Increasing money growth and inflation can be driven by many factors, not just lowering unemployment.

b. Finance persistent government budget deficits through money creation rather than issuing bonds:

This option correctly identifies one of the scenarios that can result in high inflation and money growth. Even so, it only offers a partial explanation for the phenomena outlined in the question since it does not take into account potential inflationary consequences of lowering unemployment policies.

c. Redistribute wealth from debtors to creditors:

It does not inherently result in rapid money growth or high inflation if debtors are repaid. Neither this option nor the next do directly address money growth or inflation, since it deals with redistribution of wealth.

Conclusion

Taking policies aimed at reducing unemployment or financing persistent government budget deficits can result in high money growth rates and subsequent inflation for governments. The expansionary monetary measures associated with these policies, such as increasing the money supply or financing deficits through money creation, can result in an excessive demand for goods and services relative to the available supply.

The result is an increase in prices, leading to inflationary pressures. To achieve their objectives of promoting economic growth, managing unemployment, and maintaining price stability, policymakers must recognize the inflationary consequences of these policies.

Government may pursue inflationary monetary policies

Bibisha Shiwakoti

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