2. a) There are basically three ways governments can finance their spending: tax
ID: 1118944 • Letter: 2
Question
2. a) There are basically three ways governments can finance their spending: taxes, selling bonds, or printing money. Rank these three options in terms of how inflationary they should be. Graph three AD curves in price-output space, one for each option. (Exactly where our curves are is not important; what matters is their relative position; G is the same in all 3 cases.) b) During the US Civil War the South obtained 6% of its funds from taxes, 35% from selling bonds, and 59% from printing money. The North raised 21% from taxes, 66% from bonds, and 13% from printing money. Which side probably suffered higher inflation and why?Explanation / Answer
Taxes
Selling Bonds
Printing Money
Taxes:
With the increase in the taxation by the government on the economy, the money is removed from the market. With less money available in the market the inflation is supposed to drop (just like with higer interest rates from the government). So with the increase in the taxation, the inflation can be controlled.
Selling Bonds:
The selling of government bonds in the economy will takes out money circulating in the economy which will supress the inflation in the economy. Selling bonds results in less money chasing the same amount of goods. This is because when bonds are purchased, money/liquidity is removed from the economy, so the price of goods will decrease. This is how inflation is reduced.
Printing Money:
Adding currency to National Economies doesn't necessarily cause Inflation - that only happens when the Central Bank overdoes it. Central banks have to add currency to an economy on an ongoing basis when there is Economic Growth so that the Money Supply more or less matches the total value of available goods & services.
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