The impact of deficit financing in developed countries economics essay

Meaning of Deficit Financing: Deficit financing in advanced countries is used to mean an excess of expenditure over revenue—the gap being covered by borrowing from the public by the sale of bonds and by creating new money.

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Secondly, in India, deficit financing is associated with the creation of additional money by borrowing from the Reserve Bank of India. On the horizontal axis the volume of deficit financing and on the vertical axis price level is measured. The end result is hyperinflation. But at the same time it helps economic development. Governments usually resort to this technique since public hardly opposes it. Again, a persistent deficit financing policy would soon directly lead to inflationary price rise. Again, in LDCs, developmental expenditure is often pruned due to the shortage of financial resources. On the other hand, borrowing involves payment of interest cost to the lenders. The aim of this paper is to consider the inflationary effect of deficit financing in Nigeria and ascertain the measures that are put in place by government to eradicate the negative impart of deficit financing in Nigeria. Consequently, prices of non-agricultural goods rise. If the government fails to stabilize the price level, rising prices lead to increased costs which compel the government to mobilize additional revenues through deficit financing. Due to all these obstacles these countries suffer from deficiency in effective supply rather than deficiency in effective demand. Secondly, deficit financing-led inflation helps producing classes and businessmen to flourish. However, the rise in prices must be a short run phenomenon. Unless inflation is controlled, the benefits of deficit-induced inflation would not fructify.

But deficit financing immediately releases monetary resources leading to excessive monetary aggregate demand which creates demand-pull inflation. If the government fails to stabilize the price level, rising prices lead to increased costs which compel the government to mobilize additional revenues through deficit financing.

Effect of deficit financing on prices

Advantages and Disadvantages of Deficit Financing: The most easiest and the popular method of financing is the technique of deficit financing. It is due to lack of complementary resources and various types of bottlenecks that actual production falls short of potential output. As there is no excess capacity in the economy, such increased money income results in an increased aggregate expenditure— thereby fuelling inflationary rise in prices. While empirical resolution of the crowding-out hypothesis appears off in the future, simulation analyses described here provide strong warnings about the potential long-term detrimental consequences of economic deficits. As a result, inflationary effect will be neutralized. Consequently, a rapid economic development will take place in these countries. This causes low productivity and low output. Unless inflation is controlled, the benefits of deficit-induced inflation would not fructify. The Keynesian analysis ascribes inflation to be the result of excess of aggregate expenditure over national income at full employment level. The National Planning Commission of India has defined deficit financing in the following way. Saving propensities of the former are considerably higher. In India, and in other developing countries, the term deficit financing is interpreted in a restricted sense. The aim of this paper is to consider the inflationary effect of deficit financing in Nigeria and ascertain the measures that are put in place by government to eradicate the negative impart of deficit financing in Nigeria. Such investment leads to an increase in income—thereby setting the process of economic development rolling.

Countries like the U. Thus, this borrowing or printing of new currency is virtually a cost-free method. Similarly, public borrowing is also insufficient to meet the expenses of the state.

what is deficit financing in economics

It is to be remembered here that government borrowing from the public by selling bonds is not to be considered as deficit financing.

It is due to lack of complementary resources and various types of bottlenecks that actual production falls short of potential output. The financial strength of the government is determinable if deficit financing is made.

Above all, a mild dose of inflation following deficit financing is conducive to the whole process of development.

Attempts to regain stability at the macrolevel through fiscal adjustment achieved uneven success, raising questions about the macro- economic consequences of public deficit and fiscal deterioration.

Deficit financing investopedia

It helps economic development, although not in a great way. And, underdeveloped countries— being inflation-sensitive countries—get exposed to the dangers of inflation. The main concern with budget deficit is its financing aspect4. In other words, deficit financing is not anti- developmental provided the rate of price rise is slight. Thus a vicious circle of rising price level and increased cost sets in. Thirdly, financial resources required for financing economic plans that a government can mobilize through deficit financing are certain and known beforehand. Concept of Deficit Financing A budget deficit can be defined as the situation that arises when government expenditure is greater than estimated government revenue usually from taxation and charges for government service. But due to inelasticity in the supply of essential goods, excess purchasing power of the general public acts as an incentive to price rise. If money collected through deficit financing is spent on public good or in public welfare programmes, some sort of favourable distribution of income and wealth may be made. Seeing more profits, producers would be encouraged to reinvest their savings and accumulated profits. But private sector is shy of making huge expenditure. But a smaller dose of deficit financing in developing countries leads to a rise in price level from OP1 to OP2.

Higher profit motive induces investors to invest their resources in quick profit-yielding industries. However, this conclusion is too hard to digest.

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Economic Impact of Deficit Financing