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Government Borrowing And Inflation

All else being equal, the more money a government borrows, the more likely it is that inflation in that country will increase in the future. That’s because the government will eventually have to pay back the money it’s borrowed. It can do this by either reducing its spending (expenses) and/or raising its taxes (income) – or it can print new money. The first option, cutting spending or increasing taxes, is typically negative for the demand for money. Both of those measures slow economic growth and thus reduce people’s and companies’ need for money (since demand for money falls if people are less keen to invest or spend in an economy). The other alternative, creating new money, increases the supply of money in the economy. There is simply more money available. The rules of supply and demand apply to money as they do anything else: when demand for it goes down and/or when its supply increases, its value falls – i.e. it can buy fewer goods and services – which is exactly what happens to money when inflation is higher; they’re one and the same. Thus, higher government borrowing eventually creates the same circumstances erode the value of money – and increases inflation.

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