What is meant by direct monetisation of deficit? Will it be the comprehensive solution for the government to prevent the impending financial crisis? Critically Analyse. (200 Words)
Refer - The Indian Express
Enrich the answer from other sources, if the question demands.
IAS Parliament 5 years
What is “direct” monetisation of deficit?
The government deals with the RBI directly bypassing the financial system and asks it to print new currency in return for new bonds that the government gives to the RBI. Now, the government would have the cash to spend and alleviate the stress in the economy via direct benefit transfers to the poor or starting construction of a hospital or providing wage subsidy to workers of small and medium enterprises etc.
What are the main problems with direct monetisation of government deficit?
· The main argument against it pertains not so much to its initiation as to its end. Ideally, this tool provides an opportunity for the government to boost overall demand at the time when private demand has fallen — like it has today. But if governments do not exit soon enough, this tool also sows the seeds for another crisis.
· Government expenditure using this new money boosts incomes and raises private demand in the economy. Thus, it fuels inflation. A little increase in inflation is healthy as it encourages business activity. But if the government doesn’t stop in time, more and more money floods the market and creates high inflation. And since inflation is revealed with a lag, it is often too late before governments realise they have over-borrowed. Higher inflation and higher government debt provide grounds for macroeconomic instability.
To what level should government debt be ideally limited?
· While no ideal level of debt is set in stone (see graph, showing how government debt in the UK has fluctuated over three centuries), most economists believe developing economies like India should not have debt higher than 80%-90% of the GDP.
· It should commit to a pre-determined amount of additional borrowing and to reversing the action once the crisis is over. Only such explicitly affirmed fiscal restraint can retain market confidence in an emerging economy.
· The other argument against direct monetising is that governments are considered inefficient and corrupt in their spending choices for example, whom to bail out and to what extent.
