An analyst is evaluating the potential impact of a country's persistent large budget deficits. If the central bank attempts to 'monetize' this debt by purchasing a significant portion of newly issued government bonds, what is the most probable long-term economic consequence, assuming relatively stable aggregate supply?

Question: An analyst is evaluating the potential impact of a country's persistent large budget deficits. If the central bank attempts to 'monetize' this debt by purchasing a significant portion of newly issued government bonds, what is the most probable long-term economic consequence, assuming relatively stable aggregate supply?

Answer options:

• A decrease in the money supply and eventual deflation.
• Increased foreign direct investment due to perceived government stability. ✅ A surge in inflation and a depreciation of the domestic currency.
• A significant long-term reduction in domestic interest rates due to increased bond demand.

Correct answer: A surge in inflation and a depreciation of the domestic currency.

Explanation: Monetizing debt involves the central bank printing money to buy government bonds, which directly increases the money supply. With relatively stable aggregate supply, a large increase in the money supply leads to inflation and a depreciation of the currency.