Deficit Financing- Objectives, Types, Advantages
Learn all you need to know about deficit financing. Understand the types, objectives and advantages of deficit financing.
Izhar Ahmad6 Dec, 2023
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Deficit financing is the process of borrowing money from the public or central bank to settle the budgetary deficit between government spending and income. The objective of deficit financing is to balance the government's total spending and revenue.
It is described as follows by the former Indian Planning Commission: "The direct addition to gross national expenditure resulting from budget deficits, regardless of whether the deficits are in the revenue or capital accounts." Whenever government spending exceeds payments, the government considers the deficit financing procedure. Deficit financing, therefore, is the temporary arrangement of money using various techniques.Objectives of Deficit Financing
The main Objectives of Deficit Financing are:- To encourage the ideal resources and shift resources from useless sectors to productive sectors with the main goal of increasing national income, leading to higher economic growth.
- To lift the economy out of collapse so that jobs, income, and capital grow.
- To upgrade the country's infrastructure so that the citizens may be sure that the money they pay in tax is being utilized wisely.
- To pay expenses related to defense during war.
Types of Deficit Financing
The following are ways in which government debt can be financed:External Borrowing Method:
Governments commonly secure funds by borrowing from their citizens or foreign governments, as opposed to tapping into cash reserves with the Reserve Bank of India (RBI). This method involves a transfer of ownership of money held by the public and does not directly impact the money supply in the market.Money Printing:
This approach involves increasing the money supply by printing additional currency. However, it comes with the risk of inflation, as the augmented money supply can lead to a rise in overall prices within the economy.Internal Borrowing Method (Borrowing from RBI):
Governments may borrow directly from the Reserve Bank of India (RBI), infusing money into the economy. This injection of funds can contribute to an expansion in the money supply, potentially causing an upturn in domestic prices.Impact of Deficit Financing
- An increase in inflation is a result of an increased amount of money within the economy.
- Higher inflation leads to a decrease in the average spending level as the cost of goods and services increases, affecting people's buying power.
- The increased money supply tends to create more chances for the rich, increasing income gaps within the economy.
- It causes inflation, negatively affecting the tendency for private saving. Sustaining previous saving rates becomes impractical for people amid rising prices.
- Deficit funding negatively affects investment. In an inflationary situation, trade groups and workers often seek higher pay, leading to increased production costs. This, in turn, stops buyers from acting in economic activities.
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Advantages of Deficit Financing
Convenience for Taxpayers: It involves the government borrowing surplus funds from taxpayers, providing a convenient method that does not directly burden the taxpayer. Money Creation and Interest Payments: Through deficit financing, the government generates additional funds by borrowing from the Reserve Bank of India (RBI), and the interest payments from this borrowing flow back to the government. Enhanced Financial Strength: It contributes to bolstering the financial strength of the government. Inflation Benefits under Specific Circumstances: Despite its inflationary impact, it can be advantageous under certain circumstances, fostering economic growth. Multiplier Effect on Economic Development: It can stimulate economic development by encouraging the government to utilize idle resources, promoting employment and productivity.Disadvantages of Deficit Financing
Inflationary Consequences: It consistently results in inflation, and unless inflation is controlled, the positive outcomes of deficit-induced inflation remain unrealized. Class Disparities and Economic Distortion: Inflation driven by it, benefits producers and businessmen but adversely affects fixed-income earners, widening the gap between these two classes. Distorted Investment Patterns: It distorts the usual patterns of investment in the economy. Limited Impact on Employment: It may not effectively contribute to the creation of employment opportunities. Capital Flight and Scarcity: The decline in the purchasing power of money due to inflation may lead to a flight of capital abroad, resulting in a scarcity of capital within the country.| Read Related Topics | |||
| Reverse Repo Rate | Suit for Damages | Business Correspondence | Capacity to Contract |
| Subfields of Accounting Types | Accounting Policies | Statutory Audit | Basic Problems of an Economy |
Deficit Financing FAQs
What is called fiscal deficit?
Fiscal deficit is the gap between a government's total expenditures and its total revenue, including loans, during a fiscal year.
What is the primary deficit formula?
The primary deficit is calculated by subtracting interest payments on existing debt from the fiscal deficit.
What if the primary deficit is zero?
If the primary deficit is zero, it indicates that the government's non-interest expenditures are covered by its non-borrowed revenue.
How can we control the fiscal deficit?
Fiscal deficit can be controlled by reducing government spending, increasing revenue through taxation, and implementing sound fiscal policies.
What is the debt-to-GDP ratio?
The debt-to-GDP ratio is a measure comparing a country's total debt to its gross domestic product, indicating the level of a nation's indebtedness relative to its economic output.
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