Author Question: Explain how the government gains revenue during inflation. What will be an ideal ... (Read 46 times)

ss2343 · **on:** Jun 29, 2018

Explain how the government gains revenue during inflation.

What will be an ideal response?

Question 2

Suppose that the free market exchange rate for the dollar is 115 yen, but the U.S. and Japanese governments want it to be 120 yen/dollar. What can the governments do? Illustrate your answer with a graph.

What will be an ideal response?

lindahyatt42 · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

The government issues securities and buys goods and services with the funds it raises. When the securities are bought by the Fed, money is created and the result is inflation. The government owns the Fed, so when the government pays interest to the Fed, the Fed returns the interest to the government and there is no overall cost to the government from issuing the securities. As a result, the government gets the revenue from selling the securities.
Furthermore, as the incomes of households and firms increase during inflation, they move into a higher marginal tax brackets and consequently pay higher taxes. The higher taxes are another source of government revenue from inflation.

Answer to Question 2

As is shown in the graph, the initial demand and supply for the dollar intersect at an exchange rate of 115 yen/dollar. In order to raise the price of the dollar, the governments need to increase the demand for the dollar (shown in the graph as a shift in the demand curve). They would do this by selling yen for dollars until the exchange rate rises to the desired level of 120 yen/dollar.