Deficit Financing

Deficit Financing: Useful notes on Deficit Financing

Deficit Financing: Useful notes on Deficit Financing – Explained!

The term “deficit financing” in India refers to the entire net credit extended by the Reserve Bank of India to the central and state governments to meet their budgetary deficits.

Many economists have assumed deficit financing as an effective means for financing development plans of less developed countries. In this context, there are two opinions. One group of economists believes that deficit financing should be adopted as a continuous measure for financing development plans of developing economies.

These economists argue that when deficit financing is meant for financing developmental expenditure which is allocated for those projects which yield quick returns, so with full increasing supply of real goods, inflationary pressure will be nullified.

In this case, deficit financing will tend to be self-defeating. Again with the rising income then, more savings will be generated which will make it possible to have further investment on a larger scale. Prof. Hirschman’s theory of unbalanced growth also advocates a continuous dose of deficit financing for accelerated economic growth.

Another group of economists, on the other hand, believes that deficit financing should be taken as a temporary sporadic measure to overcome deficiency of investment in the economy.

These economists argue that deficit financing should be undertaken to finance heavy industries projects and construction of social overhead capital which have a long gestation period. But it should be for a short while if continuous deficit financing is used to finance such projects, it will cause inflation.

Indeed, deficit financing is a more attractive measure than taxation to a finance minister. But, one should not resort to deficit financing limitlessly. It should be moderate.

Deficit financing can give a boost to the development process. It makes optimum use of unutilised resources possible through effective mobilisation in the country’s economy. Again, deficit financing may cause a price rise and reduction in consumption.

Thus, it implies a forced saving. Since poor countries lack voluntary savings, forced savings through deficit financing is a much desirable phenomenon. When this forced saving leads to capital formation, productivity and output increase, and bring down the price level. Thus, inflation for the purpose of capital formation is in due course self-destructive.

As IMF Staff Papers write, “the expansion of money supply within proper limits in a growing economy represents and increment of real resources for investment so long as the expansion of money supply (caused by deficit financing) is no more than enough to finance the larger volume of production, consumption, and investment at stable prices; it is not only non-inflationary, but is essential to the proper functioning of the economy.”

However, deficit financing should be used with care.

The following points must be borne in mind:

1. It should be used only moderately.

2. A constant vigil must be fixed on price indices while resorting to deficit financing.

3. The prices of essential goods should be controlled. Food supplies should be adequately arranged to stabilise food prices.

4. Cost-push inflation should be checked by checking a rise in wages and salaries.

5. By direct taxation, excessive purchasing power should be mopped up.

6. Public administration should be efficient and honest.