Final answer:
Inflation is not a direct way for governments to default on debts, but it can contribute to a situation where governments are unable to repay their debts. Large budget deficits and high inflation can lead to default and negative economic consequences. Governments must manage their spending and debt levels to avoid these risks.
Step-by-step explanation:
Inflation is not a direct way for governments to default on a portion of the debts they owe. However, large budget deficits and high inflation can create a situation where governments are unable to repay their debts, leading to default.
When a government has extremely large budget deficits, it may resort to inflationary tactics to reduce the real value of the debt outstanding.
By letting inflation rise above the fixed interest rate of the borrowing, the government effectively repays the debt at a negative real interest rate.
The risk of high inflation or defaulting on repaying international loans can worry international investors, as it implies that the rate of return on their investments may be lower than expected.
This can lead to a scenario of less investment, a depreciated exchange rate, widespread bank failure, and deep recession. It is important for governments to manage their spending and debt levels to avoid these negative impacts.