Presented By-
Deficit financing refers to means of financing
the deliberate excess of expenditure over
income through printing of currency notes or
through borrowings
Western Approach - Financing of a
deliberately created gap between public
revenue and expenditure or a budgetary
deficit. This gap is filled up by government
borrowings which include all the sources of
public borrowings
Deficit financing in Indian context occurs
when there are budgetary deficits.
Budgetary deficit refers to the excess of total
expenditure (both revenue and capital) over
total receipts (both revenue and capital).
According to Indian budgetary documents
government resorting to borrowing from the
public and the commercial banks does not
come under deficit financing
In the Indian context, public expenditure,
which is financed by borrowing from the
public, commercial banks are excluded from
deficit financing.
While borrowing from the central bank of the
country, withdrawal of accumulated cash
balances and issue of new currency are
included within its purview
Deficit financing during war
Deficit financing has its historical origin in
war finance.
At the time of war, almost every government
has to spend more than its revenue receipts
from taxes and borrowings.
Government has to create new money in
order to meet the requirements of war
finance.
Deficit financing during depression
The use of deficit financing during times of
depression to boost the economy got
impetus during the great depression of the
thirties
During depression, government should resort
to construction of public works wherein
purchasing power would go into the hands of
people and thereby demand would be
stimulated.
Deficit financing and economic development
Deficit financing for development, like
depression deficit financing, provides
stimulus to economic growth by financing
investment, employment and output in the
economy.
Govt. uses borrowed money for increase in
social and economic infrastructure such as
schools,
hospitals,
power projects,
dams, canals
and a host of other development programs,
This helps in the improvement and
productivity of various sectors of economy.
This expenditure of Govt. increases money
supply, which increases price level in the
economy.
Increases in prices, increases profit margins
of industrialists, who in order to gain profit
further accelerate their investment.
New factories are established and capital
formation increases. Govt. expenditure and
private capital formation creates more jobs
opportunities in the economy.
Increase in employment increases demand for
goods and services and on the other side it
fosters saving as well, which again is utilized
for further investment.
Thus cycle of progress and prosperity keeps
on moving ahead.
Deficit financing has to be tolerated, at least
in the developing economies, only to the
extent it can promote capital formation and
economic development. This extent of
tolerance is called the safe limit of deficit
financing.
Factors that affect deficit financing, can be
put under two categories :
(a) factors related to demand for money and
(b) factors related to supply of money.
If the demand for money is low in the
economy, the safe limit of deficit financing
will be low.
On the supply side of money, if due to some
factors the supply of money or purchasing
power with the public increases, other things
being equal, it will have an inflationary
tendency and the safe limit of deficit
financing will be low.
Safe limit depends on the nature of
government expenditure for which new
money is created, i.e., the purpose of deficit
financing.
If the newly created money is used for
unproductive purposes, the use of deficit
financing will be inflationary and the safe
limit of deficit financing will be lower than if
the newly created money is to be used for
industrial development or for intensive
farming.
Time lag between the initial investment and
the flow of final products also determines the
safe limit of deficit financing.
If the rate of growth of population is high
then low deficit financing is good and vice
versa.
The safe limit of deficit financing depends on
the supply elasticity of consumption goods in
the country.
The policy of deficit financing should be
adopted as a last resort, after exhausting all
other possible sources of development
finance.
Investment should be channeled into those
areas where capital output ratio is low so that
returns are quick and price rise is not
provoked.
Along with deficit financing, government
should adopt policies of physical controls like
price control and rationing etc.
Import policy should allow import of
necessary capital equipment for economic
development and consumer goods required
by the masses alone. Import of luxury and
semi-luxury goods should be discouraged.
Deficit financing and credit creation policies
should be integrated in such a way that
neither of the two sectors (public or private)
is handicapped due to shortage of financial
resources and, at the same time, inflation is
also kept in check in the economy.
Deficit Financing is the amount by which a government,
private company, or individual's spending exceeds income
over a particular period of time income through printing of
currency notes or through borrowing, also called simply
"deficit," or "budget deficit.
It Provides stimulus to economic growth by financing
investment, thereby generates income and employment in the
economy through multiplier effects.
◦ Multiplier effect : The doctrine of multiplier states that any
given increase in investment (private or government) will
result in an increase in national income as a. multiple of the
increase in investment.
Deficit financing has proved to be
conducive to economic development,
especially in countries with acute shortage
of Capital in breaking the vicious circle of
poverty and uplifting the economic
conditions.
It is not limited to government use.
Businesses of all sizes may choose to spend
more money up front in hopes of
generating funds to pay off the investment
at a later date.
It can be good or bad.
◦ If the government borrows (runs a deficit) to deal
with a severe recession (or depression), to help self-
defense, or spends on public investment (in
infrastructure, education, basic research, or public
health), the vast majority of economists would
agree that the deficit is bearable, beneficial, and
even necessary.
◦ If, on the other hand, the deficit finances wasteful
expenditure or current consumption, most would
recommend tax cuts to stimulate private investment,
transfer cuts, and/or cuts in government purchases
to balance the budget.
The idea of resorting to deficit financing for economic
development has remained very controversial. There are
no two opinions regarding the evil consequences of
deficit financing, when adopted carelessly for capital
formation for economic development. But the problem
is to chose between the two evils
◦ to adopt deficit financing for capital formation and
face inflation or
◦ to go without development programmes due to
insufficient of funds
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Deficit financing and economic development
in India By Manorma Hukku, Unit-14
