When the government engages in debt financing to fund a budget deficit:

Question

Quizplus · Accepted Answer

When government engages in debt financing to fund a budget deficit, it issues government securities such as treasury bills, bonds, etc. If these securities are bought by the private sector or overseas financial institutions, national debt will rise. This is because the government has to pay back the principal amount along with the interest to the holders of these securities. As a result, the overall debt level of the country increases.

Option A is incorrect because the money supply will not necessarily increase. It depends on whether the government uses the money raised through debt financing to increase its spending.

Option B is incorrect because monetization of government securities refers to the practice of the central bank creating new money to purchase these securities. This is not the case when the private sector or overseas financial institutions buy these securities.

Option D is incorrect because when the RBA buys these securities, it effectively creates new money in the economy. This can result in an increase in the money supply, but it does not necessarily mean that the national debt will rise.

When the Government Engages in Debt Financing to Fund a Budget