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Sunday, 22 May 2011

Deficit financing is an important source of investment for economic development

Deficit Financing :-
Professor Dillard says that the programed of public investment should be financed by the borrowing rather than by taxation this kind of borrowing is called deficit financing.

If during given period of time the expenditure of government exceeds than its revenue and the deficit it met by borrowing, it is called deficit financing.
Government adopts two methods in this regard.
1. Government uses the cash balances of the past.
2. Government borrows from the central bank which issues the paper currency.
So we can say that deficit financing ultimate result is the creation of proper money.

Deficit Financing and the Developing Countries :-
In the developing countries capital resources are inadequate for financing the economy development. The rate of taxes can not be increased because the rate of savings ans consumption will fall. The rate of saving is already very low due to low per capita income. So government adopts the deficit financing policy to break the vicious circle of poverty.

Effect on Deficit Financing :-
When the government expenditure is financed by the created money, it lead to inflation in the country. The classical economists say that in a capitalistic economy there is always a tendency for the economy to operate at the level of full employment. When there is full employment and we use this policy the inflation rate will raise.
But Keynes is not agree with them, he says that when there is a large scale of unemployment and the resources of the country are not being fully utilized deficit financing policy is very helpful in improving the economic condition without inflation. Today this policy is commonly used in all the countries. The poor countries are using this policy to utilize their unemployed resources. These countries are using the deficit financing for the construction or roads, railway, canals and factories.
The advanced countries are using this policy to maintain the effective demand. But there is time gap between the pumping of money into the hands of people and the establishment of schemes of development.
If the extra demand is increased due to the creative money, it is matched by the extra supply of goods then prices will not rise. If the time period between input and output is long then prices will rise for the particular time period and economy will face the inflationary pressure. On the other hand if the time is shorter between the consumption and completion of development schemes, then inflationary pressure will be slow.

One thing should be noted that the relation between prices and created money may be different. A 100% rise in the money supply may create only 10% rise in the prices of the commodity.

The rising of price due to the deficit financing depends upon various factors such as time period, consumption, savings and habits of the people.
For example if people hold or save all the created money then there will be no inflationary pressure.

HOW TO REDUCE THE INFLATION PRESSURE OF DEFICIT FINANCING ?

Deficit financing is very useful weapon for ensuring the high level of employment in the advanced countries. They increase the effective demand and adopt various measures to reduce the inflationary pressure. Following are the important measures which can be adopted to control inflation.

1. Formulation of Import and Export Policy :-
A country should frame its import and export policy in such a manner that the supply of an essential goods may not fall.

2. Proper Allocation of Resources :-
The rise in price due to deficit financing can be controlled by proper allocation of resources. Developing countries should prepare effective plans and resources of the country may not be wasted in non productive projects.

3. Fiscal Policy :-
The inflationary pressure can be controlled, if government increases the rate of taxes on luxuries and introduces the compulsory saving schemes.

4. Monetary Policy :-
An effective monetary policy can be adopted to reduce the inflationary pressure.

India and Pakistan are also using these weapons against the inflationary pressure to reduce the inflation.

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