The last three chapters have examined a variety of ways that a government can avoid fiscal insolvency by making a credible fiscal adjustment, that is, by achieving a credible increase in the prospective future path of its primary fiscal surpluses. Governments that already have the political and economic means at their disposal to make such an adjustment face only the need to convince their creditors that they will indeed do so (Chapter 10), whereas those that do not presently have such means face the need to implement institutional reforms (Chapter 11) or take other up-front actions (such as the privatization of loss-making state enterprises discussed in the preceding chapter) to lock in more responsible future fiscal performance. But what happens in the case of prospectively insolvent governments that fail to do any of these things, that is, that fail to make a credible fiscal adjustment? Such governments face two options: they can either rely on central-bank financing of their continued deficits, or they can cease to service their debt, effectively defaulting on that debt.

We will examine the macroeconomic consequences of debt defaults, known as debt crises, in Chapter 25. In this chapter, we will consider the other alternative. Specifically, we will analyze the implications for the economy of the government's handling its prospective insolvency by relying on central-bank financing – in other words, by printing money.