Given the government budget deficit finance constraint we discussed in class:      

                                    G - T = ? Bonds + ? Money Base + ? Foreign Borrowing

Explain briefly the problem for a developing economy trying to finance a large government deficit, where bond markets are not functioning and foreign banks are unable to extend additional loans.  

 

Answer :- In this situation government has only one choice to finance its deficit which is deficit financing which may lead to rise in inflation rate that create problem in developing courtiers.

Step-by-step explanation

There are three option that government can choose to finance its budget deficit bond market borrowing, foreign borrowing and deficit financing (Printing new notes). In this situation government has only one choice to finance its deficit which is deficit financing which is not efficient beyond the limit. Government can finance its deficit by increasing its monetary base but printing new notes can leads to high inflation in developing economy because printing new notes increases money supply in the economy that increases the demand in the market which leads to increase in price level and inflation goes up. In the developing country inflation targeting plays very important role and if this goes out of the control then economy will have to suffer.