What is the role of deficit financing on economic growth?

Answer 1

Deficit financingDeficit financing is the practice of a network or channel paying the studio that creates a show a license fee in exchange for the right to air the show. A major broadcast network will ask a program producer to share in the financial risk when considering adopting a new program to its schedule; at least for the first season of the series. The deficit is essentially the network not paying the full total of the cost to create a pilot program or of the cost of creating episodes of a new program.

Deficit financing also helps to minimize the substantial risks and costs of developing programs for the networks and gives studios initial benefits as well. The studio bears the difference between production costs and licensing fees, but recoups significantly more money if the show is sold in syndication. If the network orders enough episodes of a show, the studio can then sell the series to other markets. Deficit financing minimizes risks and costs of developing programs for networks. [6]

The impact of deficit financing on prices

India resorted to deficit financing, then largely financed through Reserve Bank's books either by printing more money or use of its foreign exchange reserves, right from the early years of planned economic development. However, our planners did not factor in the impact of deficit financing on inflation. But with large foreign exchange reserves, they were confident of the government's ability to manage the supply-side of the economy.

For much of the 1950s, the Bank was part of this consensus. Although the impact of deficit financing on prices had aroused concern already in 1951-52 , price stability did not return as a major cause of worry at the Bank until the mid-50 s. Besides, the Bank recognised the need for any plan to go beyond what available resources dictated, even if some part of the additional investment had to be financed through additions to money supply.

Ironically, despite the first plan document, highlighting the important role of the central bank, the Reserve Bank also took a rather modest and self-effacing view about its own part in the planning process during these years, insisting that while it was entitled to be consulted by the government regarding the dimensions of the plan effort, the final decisions rested with the latter.

One of the volumes of RBI's history notes that the central bank was not given sufficient time to consider the first Five-Year Plan, the plan document arriving in Bombay only towards the close of October 1952. Any contribution the Bank made to the first plan document appears to have been cosmetic , rather than substantial, with the Governor B Rama Rau, for instance, choosing merely to object to the plan document's suggestion that 'real democracy' implied the 'equality of incomes' .

But in the mid-50 s, the central bank started warning the government about the impact of deficit financing on inflation. In the last 15 years, with India adopting a more market-driven approach to

development, and even the concept of deficit now not including monetisation, the central bank still continues to warn the government over the dangers of high fiscal deficit on the conduct of monetary policy.

Government deficits: good or bad? Whether government deficits are good or bad cannot be decided without examining the specifics. Just as with borrowing by individuals or businesses, it can be good or bad. If the government borrows (runs a deficit) to deal with a severe recession (or depression), to help self-defense, or spends on public investment (in infrastructure, education, basic research, or public health), the vast majority of economists would agree that the deficit is bearable, beneficial, and even necessary. If, on the other hand, the deficit finances wasteful expenditure or current consumption, most would recommend tax cuts to stimulate private investment, transfer cuts, and/or cuts in government purchases to balance the budget.

DEFICIT FINANCING AND DEVELOPING COUNTRIES :-

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.

ADVANTAGES OF DEFICIT FINANCING :-

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.

EFFECTS 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.

HOW TO REDUCE THE INFLATIONARY 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 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.