Download Deficit Financing

Deficit Financing
Meaning of Deficit financing
Deficit financing is a method of meeting
government deficits through the creation of new
money. The deficit is the gap caused by the excess
of government expenditure over its receipts. The
expenditure includes disbursement on revenue as
well as on capital account.
The receipts similarly comprise revenues on
current account as well as capital account.
Creation of new money to meet the deficit in use
for a long time.
Deficit Financing:
Deficit Financing has been variously defined:
Deficit Financing is the method used to finance the overall or net budget
deficit.
Deficit Financing is the creation of additional purchasing power in the
form of currency notes.
Deficit Financing:
Deficit Financing is said to have been practiced whenever the government
expenditures exceeds the government receipts from taxes, fee etc it then
adopts any one or all of the following methods:
1.
Utilization of the past savings:
A government draws upon the cash balances of the past for meeting the
budget deficit.
2.
Printing New Currency:
A government borrows from the central bank of the country. The
central bank prints new currency in the amount borrowed by the
government.
3.
Foreign Aid:
The government borrows from developed countries
Why Deficit Financing?
Deficit financing is a very delicate tool of resource mobilization. It is
liberally used by a hard pressed government for raising revenue. The main
reasons for the use of deficit financing are:
1. Covering the Receipt-Expenditures Gap:
the government receipts through taxes and other sources are not adequate to
finance the development expenditures. The government has not been able
to fill the gap between the total receipt and the total expenditure by levying
new taxes or increasing the rates of existing tax beyond a certain limits to
avoid displeasure of the people, the government has been choosing an easy
path of deficit financing or creation of new currency.
2. Low Savings:
The people in LDCs are consumption-oriented. Due to high propensity to
consume, the domestic saving rate as a percentage of GNP is very low. As
such the government is compelled to use deficit financing as an instrument
of economic development.
Reasons for Deficit Financing…continued
3. Inadequate Banking Facilities:
the financial institutions which mobilize savings particularly in the rural
areas are inadequate. The government is therefore, not able to mobilize
resources to the desired extent.
4.Rapid Growth of Population:
The rapid rate of population growth is swallowing up whatever little
economic progress is made. The government is anxious to speed up the
economic development in the shortest possible period of time and is using
the method of deficit financing.
5. Uncertainty in getting foreign assistance:
Though the LDCs have been receiving foreign assistance yet the amount of
aid received has always remained uncertain. The government for increasing
the rate of investment and coming out of the vicious circle of poverty has
no other way but to resort to deficit financing.
Deficit Financing is a Useful Tool?
Deficit Financing is a useful weapon for stimulating economic
development in the country. The main advantages claimed of deficit
financing are:
1.
Mobilizes additional resources for economic development:
in LDCs the rate of capital formation is very low due to the
unavailability of resources. The rate of economic development is very
low. The capital is considered as life blood of the economy. Thus the
deficit financing is a source of capital formation.
2.
Helps up in utilizing our unutilized or underutilized resources:
the rate of economic growth of the LDCs is slow because they can’t
utilize these resources fully due to the lack of capital.
Deficit financing creates additional purchasing power in the hands of
government with which the government can utilize the underutilized
and unutilized resources.
Deficit Financing a Useful Weapon?
3. Helps in building up infrastructure:
the LDCs have very low infrastructure facilities like highways, banks,
education etc. a big sum is required by the government in providing such
facilities like construction of highways, provision of electricity, water &
gas, provision of health facilities. In such situations, when the revenue of
the government is low, deficit financing is the way to meet the needs of
the government for providing these facilities.
4. Ensuring higher level of employment in the country:
in LDCs, the unemployment is a real problem. The number of
unemployed people is increasing day by day as the population increases
and also due to the unavailability of capital with the people and
government.
Thus deficit financing is the way to increase the employment in the
country. When the revenue created through deficit financing is spent on
different projects like construction of roads, irrigation, hydro-electric
generation etc. this will absorb the unemployed portion of the people.
C a u t i o n:
Deficit Financing creates inflationary pressure in the economy.
If the time lag between the injection of created money into the
economy and the completion of development projects is long and
the extra demand for goods is not matched by additional output,
there is greater inflationary pressure in the economy.
How to reduce inflation pressure of Deficit Financing:
The economists recommend following measures for minimizing the
inflationary potential of deficit financing:
1. Proper Import and Export Policy:
A country should frame its imports and exports policy in such a way that
the supply of essential commodities does not fall and they are provided at
reasonable prices in the country.
2. Control on supply of commodities:
The inflationary pressure generated by deficit financing can be reduced by
having an effective control on the supply and prices of essential
commodities. The basic commodities can be provided to the consumers at
fixed prices.
How to reduce inflation pressure of Deficit Financing:
3. Fiscal Policy:
the inflationary rise in prices can be controlled or minimized through an
anti-inflationary fiscal policy. If a government increases the rates of taxes
of the luxury good, reduces its non-essential expenditures, the magnitude of
inflationary pressure will be reduced.
4. Monetary Policy:
An effective monetary policy can also go a long way in minimizing the
inflationary pressure of deficit financing..
Summing Up, the use of deficit financing for economic development may
be linked to fire which if unregulated produce havoc while regulated gives
light and warmth.
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