Deficit Financing

When the expenditure of the government is higher than the revenue that the government earns from taxes, surplus funds from public enterprises, and loans from the central bank, the government deals with the situation by printing more currency by buying or lending from foreign institutions. This arrangement of money to control the revenue deficit is known as deficit financing. In other words, deficit financing is the addition of the cost to the gross domestic expenditure creating a budget deficit that can either be from the revenue or capital account. Deficit financing is different in the Indian context and the western context, but almost all the developed nations, along with the practices of the developing nations, rely on deficit financing systems. 

The term deficit financing in the west is referred to as a deliberate financing measure to create a gap between the revenue of the state and the public expenditure. This is said to be a financing method of borrowing that helps put an additional net national layout value or aggregate expenditure. This in turn either helps in creating an idle deposit that the private individuals are doing in banks or by the banks that have undertaken the purchases of the government securities directly. Thus in the absence of deficit financing, there is an increase in the average national expenditure than the already prevailing one. In The US, deficit financing is created by raising the current national expenditure more than the revenue. This is supported by the excess circulation of new currency by the government or by the public borrowings from the banks. 

In India, deficit financing is used in a different sense than in the United States. In India, deficit financing is mainly followed in order to expand the currency in the country. It has been one of the most successful measures for the addition of new financial resources to induce the growth of the economy. The deficit financing in India includes borrowings from the central banks, excluding the market borrowings and the withdrawal of the cash balance that is money lending from the public and the private sector banks. As the public loans are raised by the deposits of the public thus by the deficit financing measures of the government, the purchasing power transfers from the hands of the public to the government without any mere change in terms of the net addition to the national expenditure. Thus this explains clearly “what is deficit financing” and “what deficit financing stands for”. 

Objectives of Deficit Financing

In the modern-day fiscal policies in order to ensure the consistent growth in the income of the expenditure of the public at various layers of government, deficit financing is taken to be the import tool in the form of a financing method.  After having a brief knowledge about “what is deficit financing” let us now have a look at the major objectives of deficit financing followed by economies of the world are listed below in order to attain financial stability:-

• During the emergency situation, the government uses the deficit financing tool as a form of effective fiscal key to meet the financial requirements of the government of a definite country.

• In order to raise the level of out and to control the economic fluctuations of the country, the government use Keynes's popularised deficit financing as an effective fiscal in­strument. 

• In order to mobilize resources for planned economic develop­ment for developing countries, deficit financing is considered as a key method. 

• During the time of the depression of an economy, the prime objective of deficit financing was to stimulate private spending by giving a boost to the level of effective demand. 

• The major objective of deficit financing in developing countries is to remove the critical aspects that majorly hinder economic growth, such as unemployment, poverty, and the low income of most people. 

• In the time of the depression, in order to boost economic development, JM Keyes advocated that deficit financing is the major tool for utilizing various idle unutilized resources and mobilizing surplus labour. 

Sources of Deficit Financing

The major sources of carrying out deficit financing in an economy are as follows:-

• Rising the money flow in the market by printing new currencies.

• Borrowing from the source of public sectors like Reserve Bank of India, Ad-hoc treasury bills, the general public in the form of tax, and from government bonds.  

• Lending money from external sources like borrowing from big economic institutions, from the developed countries, IMF, World Bank, etc. 

Importance of Deficit Financing in India

The importance of deficit financing in India is experienced only when the income and the revenue of the government fall below the expenditure. At that time:-

• The government takes out some of the cash deposits from the reserve bank of India. 

• The government orders RBI to print new currency notes. 

• Borrow money from the general public in the form of securities like bonds.

• With the help of Ad-hoc treasury bills, the central government borrows money from the public as well as private banks and also from state governments if necessary. 

But the main concern with the rise of the sudden money flows in the market because of all the above measures that the government takes leads to the increase in the inflation rate within the economy of the country.  

Effects of Deficit Financing

One of the famous economists of all time named Keynes was a very strong supporter of the deficit financing tool to be implied in all the developing countries. According to him, this was only the effective method to break the vicious circle of poverty, unemployment, and underproduction within an economy. This is the major reason that most of the developed and rich countries often incorporate the deficit financing tool to boost their economy from time to time. But having said that, there are various impacts that have been observed while implying deficit financing. These are are the following points that describe “what are the effects of deficit financing on the economy”. 

• As the supply of money increases, the inflation rate also increases accordingly.

• Due to the result of the inflation rate, the average consumption level decreases rapidly.

• As there is a sudden money flow in the market, the disparity between classes also increases. It is because the rich get more opportunities to earn money, whereas the conditions of the poor deteriorate due to inflation.

• Inflation also affects voluntary savings, and the biggest challenge of deficit financing is the hike of the inflation rate. Thus it is not possible for the general public to maintain the same rate of saving as it was before inflation as the expenditure with the high inflation also rises.

• Also, the investments are affected adversely because of the inflation rate going up. It is because, as inflation rises, the expenditure rises. Thus the employees and the union leaders demand more wages to survive. As it becomes important to increase the wage, automatically the cost of production rises that demotivates the investors to do any further investments.