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  1. So when governments are big borrowers, higher inflation becomes an incentive, as this means it costs them less in real terms on repayment of their debt. Futhermore, due to their huge debt… their ability to raise interest rates is limited i.e. higher interest rates means higher interest expense. Is that a fair observation?

    • Generally higher inflation means higher interest rates because borrowers have to be paid enough to keep up with inflation, so inflation is a ‘two-edged sword’. Yes, the real value of debt repayments goes down but the interest rate that has to be paid on new borrowing will go up.

      If a Government has issued debt in the past (eg 2% Treasury Bonds) if interest rates are raised to 4%, the cash outflows to service that old debt do not change. The 2% is the coupon rate which means that if you hold $100 nominal of the bond you will get $2 per year. However, when it comes to issuing new debt the government would have to offer an interest rate that keep up with inflation and which offers a real return to lenders so higher interest cash outflows.

      • When the government spends too much money and borrows from the economy to support it, there is an effect called the exclusion effect. To finance borrowing, the government raises the interest rate to encourage financial investors to buy treasury letters. Because of this, companies and people have more expensive loans and stop investing. The value of the government expenses increase will be compensated by the reduction in private investment. On the other hand, if the government funds the expenditure by printing money, we have pressure on the economy and the prices rise causing inflation, because of this the “real value economy” drops, and the people with the same amount of wages cannot buy the same number of “real goods and services” and the measure becomes in some tax, this is known as the Oliveira Tanzi effect because these two economists made a deep study about this.

  3. Hi,

    Can you please elaborate the point on increased government spending at the slide on 18:52 in the video?
    How does increased government spending lead to a rightward shift in demand?

    Thanks,
    MD.

    • If money supply is increased, for example by making borrowing easier, then both individuals and companies will have more money to spend and there will be greater demand for goods. Greater demand tends to push up prices because of competition for goods and just greater affluence.

    • Various ways.

      For a single item it is simply something like Price at a data in 2020/Price on the same date 2019.

      For more general inflation rates a typical ‘basket’ of products is chosen eg 2kg potatoes, 1 litre milk, 2 kgs apples, 20 litres fuel…..etc.

      The price if the basket is worked out for 2020 and for 2019 and the ratio gives an inflation rate. However, this is complicated by the fact that the typical ‘basket’ changes over time eg dairy milk might become less popular and soya milk more popular. A decision has to be made about which mix of goods is to be used in the calculation.

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