Canadian Securities Course (CSC) Level 1 Practice Exam

How do governments typically finance the national debt?

1. By reducing public services

2. By increasing taxes

3. By issuing debt instruments and borrowing from the markets

4. By printing more money

The correct answer is: By issuing debt instruments and borrowing from the markets

Governments typically finance national debt through the issuance of debt instruments and borrowing from the markets. When a government needs to raise money to cover deficits or to refinance existing debt, it issues bonds or other types of securities. Investors, including individuals, institutions, and foreign governments, purchase these instruments, providing the necessary capital to the issuing government. In return, the government commits to paying back the principal amount at a designated maturity date and often pays interest to the bondholders at regular intervals. This mechanism allows governments to raise funds without immediately needing to increase taxes or reduce public services. Borrowing through the issuance of debt instruments is often preferable for managing national debt, as it can be more efficient and less disruptive compared to alternative methods. Using tax increases or cuts in public services could lead to economic contraction and dissatisfaction among citizens, while printing more money risks inflation and undermines the value of the currency. Therefore, issuing debt instruments effectively balances the need for funding while managing the impacts on the economy.