Why are high bond yields a problem?
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With regard to the following practice question: Over time, if a nation borrows excessively, the interest rate on their loans will reach a critical level— that is, the interest rate on future loans is too high for the country to afford. If a country cannot borrow, it has only a few options to resolve it *
Surely the answer here is either default or get bailed out or a bit of both as has been managed for Greece. Inflation is not an option for a country in the Eurozone for the reasons stated by Carola Binder above. So are the answer options you presented incorrect?
I'm not sure I understand this concept:
"Over time, if a nation borrows excessively, the interest rate on their loans will reach a critical level— that is, the interest rate on future loans is too high for the country to afford. If a country cannot borrow, it has only a few options to resolve it; (a) default, (b) inflation (c) outside help/bailouts"
Would the answer to this question not be either (a) or (b) or maybe a combination of the two? Inflation would occur organically/naturally as a result (if I am not mistaken). What am I missing here?
I believe Eugene's observation is spot on. Lets take a hypothetical country X, and say that currently it's yields on bonds is high, so is the borrowing rate of interest( they are correlated), which would obviously mean that the bond prices are low.
Now come OMT and a huge chunk of those low priced bonds are bought by ECB. Supply constant and demand rises, the price of the bond goes up. And so does the liquidity in the market, while bringing the yield down. As soon as liquidity/credit increases, it boosts inflation.
So as Eugene said, OMT is implicit inflation
Thanks and please correct me if am mistaken.
The debt problem also becomes worse overtime by "compound interest" which further rises the debt level. This is why debt usually shows exponential growth if no new fiscal policies are introduced and economic growth stagnates.