Deficit financing and economic development.

 The  phrase  ‘ Deficit financing’  is  used  to  mean  any public  expenditure  that is  in  excess  of  current  public  revenues . In  advanced   countries  deficit financing  is  used   to  describe     the   financing  of  deliberately  created   gap  between  public  revenue  and  public  expenditure  or  a  budgeting  deficit .  Thus  Govt.  expenditure  financed  by  borrowing  from  the  public  is  included   in  deficit  financing .  Another  method  usually  followed  is  deficit  financing by ‘ created  money’. Deficit  financing  in  context  of     an LDC’s[ Less  developed  countries] has  a  different  connotation.  It      includes  expenditure  financed  by  borrowing  from  the  public . According   to  the  Indian Planning  Commission , ” The  term  deficit  financing   is  used  to  denote  the  direct  addition  to  gross  national  expenditure through  budget  deficits , whether   the  deficits  are  on revenue  or  on  capital  account .  The  essence  of  such  a  policy  lies in  the  Govt. spending  in excess  of  the  revenue  it  receives  in  the  shape of  taxes , earnings  of  state  enterprises, loans  from  the  public , deposits  and  funds   and other  miscellaneous  sources. The  Govt.  may  cover the  deficit  either  by  running  downs  its  accumulated  balances or  by  borrowing  from  the  banking  system[  mainly  from  central  bank  of  the country and thus ‘created money ‘]. Thus  deficit financing  includes:[a] withdrawal  of  past  accumulated  cash  balances  by  the  Govt., [b] borrowing  from  the  central  bank and [c] issuing  of  new  currency  by  the  govt. In India  these  methods are  in  use.  

 

Role   of    Deficit  financing :-

                                                                                  Deficit  financing  is   the  most  useful  method  of  promoting  economic   development  in less  developed  countries .  Generally  less  developed  countries  suffer  from  lack  of  sufficient  financial resources  to  support  required  investment  to  promote  economic  development. So  on   account  of  the  lack  of  sufficient  resources  to  finance  public  investment,  govt.  have  to  resort  to  the  method  of  deficit  financing. 

                                                                                        Deficit  financing  may be  used  for  the  development  of  economic  and  social  overheads  such  as   construction  of  roads , railways , power projects , schools, hospitals etc . By  providing  socially  useful   capital , deficit  financing  is  able  to  break  bottlenecks  and  structural  rigidity  and  thereby  increases  productivity. 

                                                                                        Further , deficit  financing  by  increasing   money  incomes  augments  community  savings . It  is  an  effective  instrument  of forced   savings . When   the  Govt.  resorts  to  deficit  financing, it  takes  away  real   resources  from  the  people.  Moreover  deficit  spending  by  the   state  on  development  projects  leads  to  increased  employment , output  and income .  The  increased  incomes  tends  to  raise  the  demand  for  consumer  goods  which  leads   to  the  rise  n  prices  due  to  deficit  supplies  . This  process  leads  to  inflation.  In such   a  situation , a  part  of  the  increased  incomes  can  be  taken  away  through  taxation  by  the   Govt. It  is  another  way  of  forced  savings  which  can  be  utilized  for  capital  formation.   

                                                                                     The  rationale  of  deficit  is  that  it  tends  to  raise  the  income  of  the  enterpreneurial  class  which  has  a  high  propensity  to  save . During  inflationary  periods  , wages  and other  fixed  costs do  not  rise   to  the  same  extent as  the  rise in  prices . This  tends  to  raise  profits  which  are used  for higher  investment  and  capital  formation .  At  the  same  time  inflation  tends  to  reduce   the  real  income  of  the  fixed  income group and  thereby  their  propensity  to  save . But  the  loss  in  the  propensity  to  save  of   the  fixed   income earners  is  compensated  more   than proportionately  by  the   rise  in  the   propensity  to  save   of  the  variable  income  earners .  Deficit  financing  thus  combines  in  itself  both  the  fiscal  and  monetary    polices . It  acts  as  a fiscal  measure  which  inflation  operates as an  engine  of  forced   saving  through  taxation . It  is a monetary  measure  when  it  creates  new money  through  a deficit  budget. 

             Deficit financing  is  always  expansionary   in  its  effects, as  development  gains  momentum  the  rate  of  investment in  the  economy  is  accelerated  which  requires a  additional  does of the  quantity  of  money at every stage – [a]  With  a continuous  increase  in  investment  the total  physical  product  is  likely  to  be  higher   than  before  thereby  necessitating  a  corresponding  increase  in  supply of  money  for  transaction  purposes.[b]  As  the  economy develops  the non- monetized  sector  is  gradually  transformed  into the  monetized  sector leading  to  an  increase  in  the demand  for money. [c]  A  process  of  continuous  economic  development  leads  to  rise  in  incomes  thus  increasing  the  demand  for  cash  balances  on  the part of  the  people. [d]  In  the  event  of an import  surplus  due  to increasing  foreign  aid , the  demand  for  money  is  likely  to  be  still  greater . It  is  through  deficit  financing  that  the  Govt.  can  meet  the  increasing  demand  for  money  in  all  these  cases .   Thus  a  policy   of  deficit  financing  is  an  important  and  fruitful instrument  for  capital  formation  in  underdeveloped  countries.———————————————————————————————————————————————————————————————————————————————-The  End.—————————————————————————-

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