The government can’t keep borrowing over and over again


Of course, initially, this will not lead to an increase in inflation because, concomitant with this surge in demand, production capacity will start up as the virus recedes. At some point, however, full capacity will be reached and at that point further growth in demand would lead to inflation.

As this happened, political authorities would have a number of options. First, they could tighten fiscal policy by cutting spending and / or increasing taxes. Second, they could soak up excess liquidity in the system by selling bonds in the markets (i.e. if they weren’t canceled, perhaps the ones the Bank bought earlier). Third, they could raise short-term interest rates. Fourth, they could introduce various forms of direct checks on bank loans.

If past experience is anything to say, they will likely employ a combination of the four options. But that would not serve to overcome their drawbacks. Fiscal tightening, while it may prove inevitable at some point, is potentially damaging to productive capacity and would be politically damaging.

Selling debt in the markets may seem painless, but it would serve to lower the price of government debt and raise its interest rate, thus increasing the cost of continuing government borrowing. Raising short-term interest rates would hurt the economy and also increase the cost of public finances. Controls on bank loans would undermine the efficiency of the financial system.


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