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Saturday, 9 July 2011

What is deficit financing? what role does it play in the economic development of a country

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

If during a given period of time the expenditure of government exceeds than it revenue and the deficit is met by borrowing it is called deficit financing.
Government adopts two method 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 issuance certain of paper money.

There is a difference in deficit financing and deficit budgeting. When current expenditure is excess than the current revenue it is called capital account, on the other hand when current capital receipts are not adequate to meet the development expenditure and this gap is financed by borrowing from the banking system is called deficit financing.

In the developing countries capital resources are inadequate for financing the economic development. The rate of taxes can not be increased because the rate of saving and consumption will fall. The rate of saving is already very low in the less developing countries due to low per capita income. So government adopts the deficit financing policy to break the vicious circle of poverty. The main reasons for using this policy are as under :

1. To Cover the Gap :-
When the Govt. is unable to fill the gap between the total receipts and total expenditure by imposing taxes then Govt. adopts the policy of deficit financing. By adopting this way Govt. can avoid the displeasure of the people.

2. Low Savings :-
In the under developed countries normally rate of savings is 10% to 14% of the GNP which is very low. As such the Govt. of these countries is compelled to use this policy as an instruments for economic development.

3. Rapid Growth of Population :-
In the less developed countries population growth is very high. To met the needs of the people and to speed up the economic development Govt. is using the deficit financing policy.

4. Lack of Banking Facilities :-
Savings are mobilized by the financing institutions. But in the underdeveloped countries there is a shortage of these institutions particularly in rural areas. So resources are not mobilized to the desired extent and Govt. is helpless to use this policy.

5. Suspension of Foreign Aid :-
Due to delay ans suspension of foreign aid Govt. has to adopt the deficit financing policy to break the vicious circle of poverty.

Following are the important advantages of deficit financing :

1. High level of employment is ensured by the policy of deficit financing.
2. Utilized and underutilized resources can be build up with the help of this policy.
3. Additional resources can be mobilized for the economic development by using this policy.
4. Social and economic over heads can be build up by adopting the policy of deficit financing.

When the government expenditure financed by the created money, it leads 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 rise.

But Prof. Keynes is not agree with them. He says that "When there is 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 the all countries. The poor countries are using this policy to utilize their unemployed resources. These countries are using the deficit financing for the construction of roads, railways, canals and factories.
There is a time gap between the pumping of money into the hands of the people and the establishment of scheme of development.
If the extra demand is increased due to the created money, is matched by the extra supply of goods then prices will not rise. If the time period between input and output is long the 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 price of the commodity.
The rising of prices 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.

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 unproductive projects.

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

4. Monetary Policy :-
An effective monitory policy can be adopted to reduce the inflationary pressure. Most of developing countries are also using these weapons against the inflationary pressure to reduce the inflation.

5. Supply of Commodities :-
Inflationary pressure can be controlled by providing the basic goods to the consumer at fixed rates through the utility stores.


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