Deficit Financing

VKRV Rao “The financing of a deliberately created gap between public revenue and public expenditure or a budgetary deficit, the method of financing being borrowing of a type that result in a net addition to total outlay or aggregate expenditure”.

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Indian Planning Commission “ the direct addition to gross national expenditure through budget deficits whether the budget deficits are on revenue or capital account”

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Objectives:

• Mobilise idle resources
• Meet financial needs during crisis
• Finance plans
• Raise effective demand
• Set right out of depression
• Serve as an alternative tool

Role of deficit financing:

• Deficit financing and War
• Deficit financing and Depression
• Deficit financing and Economic Development
• Deficit financing and unused resources

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Advantages:

1. Tool for financing war
2. Source of development finance

3. Control deflation

4. Mobilise surplus resources

5. Source of capital formation

6. Create employment

7. Create economic and social overheads

8. Increase output and income

9. Stimulate aggregate demand

10. Alternative source of revenue

11. Effective in fighting depression

12. Quick source of revenue

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Disadvantages:

1. Inflation
2. Inequality
3. Distortion in investment
4. Effect BOP
5. Economic instability
6. Encourage speculation
7. Political consequences
8. Increased controls
9. Disturbs monetary System
10. Discourages savings
11. Self-destructive

Safe Limits of Deficit financing

1. Extent of unused capacity
2. Growth rate of income
3. Quick Yielding
4. Extent of price rise
5. Use for productive purposes
6. BOP Position
7. Effective controls-monetary and fiscal
8. Co-operation of the people
9. Production trends

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Role of deficit in LDCs

• Limited scope for other sources
• Need for increasing Capital formation
• Existence of unutilized capacity
• Finance plans
• Expand public sector
• Create overheads
• Break vicious circle of poverty
• Stimulate private investment
• Unpopularity of taxes
• Generate employment

FISCAL POLICY

Meaning

Definition: To Ursula Hicks “Fiscal policy is concerned with the manner in which all the different elements of public finance, while still primarily concerned with carrying out their duties may collectively be geared to forward the aims of the economic policy”

Otto Eckstein “Fiscal policy is defined as the changes in taxes and expenditure that aim at short term goals of full employment, price level and stability”

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Objectives of Fiscal Policy:

• To raise resources
• Achieve full employment
• Ensure optimum allocation of resources
• Achieve Economic stability
• Improve standard of living of the people
• Accelerate economic growth
• Maintain external stability
• Maintain price stability (control inflation& deflation)
• Increase CF
• Remove regional imbalance
• Reduce inequalities
• Encourage Private investment

Role of Fiscal Policy in Developing Countries:

1. Accelerating economic development
2. Promote Capital formation
3. Create employment
4. Breaking vicious circle of poverty
5. Induce investment
6. Divert investment
7. Maintain price stability
8. Redistribute income
9. Control Inflation
10. Mobilise resources
11. Balanced regional development
12. Create infrastructure

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Components of Fiscal Policy:

1. Tax Policy
2. Public Expenditure Policy
3. Public Debt
4. Deficit Financing

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Public Debt

Meaning and Definition:

In the words of Fidlay Shirras “Public debt is a debt which a state owes to its subjects or to the nationals of other countries”. According to P.E.Taylor “Public debt is in the form of promises by the treasury to pay the holders of these promises a principal sum and in most instances, interest on that principal”.

Distinction:

1. Sources: Govt. has vast, individual has limited sources
2. Govt. can use force not an individual
3. Govt. can take long term, but individual for relatively shorter

4. Public debt spent productively, private both

5. ROI is lower on public and higher on private debt

6. In case of internal debt lender also shares the burden of repayment, but individual should pay from his earnings

7. The Govt. can refuse to repay not individual

8. Govt. Can borrow huge amount not an individual

9. Govt. can borrow as a fiscal measure not an individual

10. Govt. debt has welfare impact not in private debt

Sources:

Internal

External

Types:

1. Internal and External
2. Productive and unproductive
3. Redeemable & Irredeemable
4. Funded & Unfunded
5. Voluntary & Compulsory
6. Marketable & non-marketable
7. Callable and non-callable
8. Gross and Net
9. Short-term, medium term & long term

Burden of Public Debt

Burden of internal debt

1. Direct Money Burden: In the case of internal debt there is no money burden. It is only the tax burden
2. Indirect money burden: Govt. generally spends on development. More over govt. imposes additional taxes for repayment
3. Direct real burden: Generally rich lend but taxes are paid by all. Inequality increases
4. Indirect real burden: Govt. generally impose new taxes. When indirect taxes are imposed they fall heavily on the poor

Burden of External Debt:

1. Direct money burden: There is transfer of money from one country to another including interest
2. Indirect money Burden: Paid through exports
3. Direct real Burden: Transfer of resources to foreign countries
4. Adversely affect will to work and save when new taxes are imposed.

Effects;

1. On production
2. On Consumption
3. On distribution

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