Debt monetization

However, in practice monetary financing is most usually done in a way that is reversible, for example by offering costless direct credit lines or overdrafts to the government.

Most developed countries instituted this independence, "keep[ing] politicians [...] away from the printing presses", in order to avoid the possibility of the government, in order to increase its popularity or to achieve short-term political benefits, creating new money and risking the kind of runaway inflation seen in the German Weimar Republic[8] or more recently in Venezuela.

[2] In the Eurozone, Article 123 of the Lisbon Treaty explicitly prohibits the European Central Bank from financing public institutions and state governments.

[15] When government deficits are financed through debt monetization the outcome is an increase in the monetary base, shifting the aggregate-demand curve to the right leading to a rise in the price level (unless the money supply is infinitely elastic).

[16][17] When governments intentionally do this, they devalue existing stockpiles of fixed income cash flows of anyone who is holding assets based in that currency.

This wealth transfer is clearly not a Pareto improvement but can act as a stimulus to economic growth and employment in an economy overburdened by private debt.

If the beneficiaries of this transfer are more likely to spend their gains (due to lower income and asset levels) this can stimulate demand and increase liquidity.

Conversely, tight monetary policy which favors creditors over debtors even at the expense of reduced economic growth can also be considered a wealth transfer to holders of fixed assets from people with debt or with mostly human capital to trade (a "deflation tax").

A deficit can be the source of sustained inflation only if it is persistent rather than temporary, and if the government finances it by creating money (through monetizing the debt), rather than leaving bonds in the hands of the public.

[16] On the other hand, economists (e.g. Adair Turner, Jordi Gali, Paul de Grauwe) are in favor of monetary financing as an emergency measure.

[18][19] During an exceptional circumstances, such as the situation created by the COVID-19 pandemic, the benefits of avoiding a severe depression outweighs the need to maintain monetary discipline.

[21] In July 2020, Bank Indonesia agreed to purchase approximately 398 trillion rupiah (US$27.4 billion) and return all the interest to the government.