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Causes of deficit the financing in pakistan

Meaning, Effects and Advantages! 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. In India, and in other developing countries, the term deficit financing is interpreted in a restricted sense.

The National Planning Commission of India has defined deficit financing in the following way. The essence of such policy lies in government spending in excess of the revenue it receives. The government may cover this deficit either by running down its accumulated balances or by borrowing from the banking system mainly from the central bank of the country.

There are some situations when deficit financing becomes absolutely essential. In other words, there are various purposes of deficit financing. To finance war-cost during the Second World War, massive deficit financing was made. Being war expenditure, it was construed as an unproductive expenditure during 1939-45.

Deficit Financing: Meaning, Effects and Advantages

However, Keynesian economists do not like to use deficit financing to meet defence expenditures during war period. It can be used for developmental purposes too. Developing countries aim at achieving higher economic growth. A higher economic growth requires finances.

  • In India, and in other developing countries, the term deficit financing is interpreted in a restricted sense;
  • That is to say, the multiplier effects of deficit financing will be larger if total output exceeds the volume of money supply;
  • Higher profit motive induces investors to invest their resources in quick profit-yielding industries;
  • But, LDCs are characterized by low saving-income ratio;
  • The objectives of development, the priority of the projects, the combination of factors should be carefully planned;
  • Further, deficit-led inflation tends to reduce consumption propensities of the public.

But private sector is shy of making huge expenditure. Therefore, the responsibility of drawing financial resources to finance economic development rests on the government. Taxes are one of such instruments of raising resources. Being poor, these countries fail to mobilize large resources through taxes. Thus, taxation has a narrow coverage due to mass poverty.

A very little is saved by people because of poverty. Further, there is a limit to public borrowing. In view of this, the easy as well as the short-cut method of marshalling resources is the deficit financing.

Deficit Financing: Meaning, Effects and Advantages

Since the launching of the Five Year Plans in India, the government has been utilizing seriously this method of financing to obtain additional resources for plans.

It occupies an important position in causes of deficit the financing in pakistan programme of our planned economic development. What is important is that low incomes coupled with the rising expenditures of the government have forced the authorities to rely on this method of financing for various purposes. To finance defence expenditures during war ii. To activate idle resources as well as divert resources from unproductive sectors to productive sectors with the objective of increasing national income and, hence, higher economic growth iv.

To mobilize resources to finance massive plan expenditure If the usual sources of finance are, thus, inadequate for meeting public expenditure, a government may resort to deficit financing. A budget deficit arises when the estimated expenditure exceeds estimated revenue. Such deficit may be met by raising the rates of taxation or by the charging of higher prices for goods and public utility services.

The deficit may also be met out of the accumulated cash balances of the government or by borrowing from the banking system. When the government draws its cash balances, these become active and come into circulation.

Again, when the government borrows from the RBI, the latter gives loan by printing additional currency. It is to be remembered here that government borrowing from the public by selling bonds is not to be considered as deficit financing.

Effects of Deficit Financing: Deficit financing has several economic effects which are interrelated in many ways: Deficit financing and inflation ii.

Deficit financing and capital formation and economic development iii. Deficit Financing and Inflation: It is said that deficit financing is inherently inflationary. Since deficit financing raises aggregate expenditure and, hence, increases aggregate demand, the danger of inflation looms large. This is particularly true causes of deficit the financing in pakistan deficit financing is made for the persecution of war.

The end result is hyperinflation. On the contrary, resources mobilized through deficit financing get diverted from civil to military production, thereby leading to a shortage of consumer goods. Anyway, additional money thus created fuels the inflationary fire. However, whether deficit financing is inflationary or not depends on the nature of deficit financing. Being unproductive in character, war expenditure made through deficit financing is definitely inflationary.

But if a developmental expenditure is made, deficit financing may not be inflationary although it results in an increase in money supply. To quote an expert view: In other words, inflation arising out of inflation is temporary in nature.

The most important thing about deficit financing is that it generates economic surplus during the process of development.

  • So, a compromise has to be made so that the benefits of deficit financing are reaped too;
  • That is to say, the multiplier effects of deficit financing will be larger if total output exceeds the volume of money supply;
  • The inflationary pressure generated by deficit financing can also be reduced by having an effective control on the supply and prices of essential commodities.

That is to say, the multiplier effects of deficit financing will be larger if total output exceeds the volume of money supply. As a result, inflationary effect will be neutralized.

Again, in LDCs, developmental expenditure is often pruned due to the shortage of financial resources. It is the deficit financing that meets the liquidity requirements of these growing economies. Above all, a mild dose of inflation following deficit financing is conducive to the whole process of development. In other words, deficit financing is not anti- developmental provided the rate of price rise is slight. However, the end result of deficit financing is inflation and economic instability.

Though painless, it is very much inflation-prone compared to other sources of financing. Some amount of inflation is inevitable under the following circumstances: 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.

Again, a persistent deficit financing policy would soon directly lead to inflationary price rise. It is true that the gestation period of capital goods is long. Thus, the effect of increased output can only be felt after a long time gap. But deficit financing immediately releases monetary resources leading to excessive monetary aggregate demand which creates demand-pull inflation.

Governments usually resort to this technique since public hardly opposes it. The inflationary impact becomes stronger once the continuous deficit financing is adopted. If the government fails to stabilize the price level, rising prices causes of deficit the financing in pakistan to increased costs which compel the government to mobilize additional revenues through deficit financing. This surely threatens the price stability. Thus a vicious circle of rising price level and increased cost sets in.

Thus, deficit financing has a great potentiality of fanning out demand- pull and cost-push inflationary forces. In these countries, not all aggregate demand can be met because of the low production.

It is due to lack of complementary resources and various types of bottlenecks that actual production falls short of potential output. The low elasticity in the supply of essential goods and the rising aggregate expenditures result in high propensities to consume and low propensities to save. Above all, pattern of consumption fuels inflationary price rise in these countries.

When there is an increase in aggregate demand consequent upon deficit financing, demand for food grains rise. But its price rises due to the inelasticity in supply. Consequently, prices of non-agricultural goods rise. Thus, deficit financing is inflationary in LDCs—whether the economies remain at the state of full employment or not. The impact of deficit financing on the price level in both developed and underdeveloped countries can be demonstrated in terms of the Fig.

On the horizontal axis the volume of deficit financing and on the vertical axis price level is measured. In developed countries, a rise in deficit financing from OD1 to OD2 causes price level to rise towards full employment price OP2. But a smaller dose of deficit financing in developing countries leads to a rise in price level from OP1 to OP2.

Thus, deficit financing and, hence, increased money supply is always associated with a high degree of inflation in developing countries like India. One estimate suggests that a deficit budget covered by deficit financing of one per cent leads to a rise in the price level by approximately 1. The technique of deficit financing may be used to promote economic development in several ways.

  1. Infect it is not possible for the people to maintain the previous rate of saving in the state of rising prices. It can be used for developmental purposes too.
  2. 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.
  3. Thirdly, financial resources required for financing economic plans that a government can mobilize through deficit financing are certain and known beforehand. Much success of it depends on how anti-inflationary measures are employed to combat inflation.

Nobody denies the role of deficit financing in garnering resources required for economic development, though the method is an inflationary one. Economic development largely depends on capital formation.

The basic source of capital formation is savings. But, LDCs are characterized by low saving-income ratio. In these low-saving countries, deficit finance- led inflation becomes an important source of capital accumulation. During inflation, producers are largely benefited compared to the poor fixed-income earners.

Saving propensities of the former are considerably higher. As a result, aggregate savings of the community becomes larger which can be used for capital formation to accelerate the level of economic development.

  1. Saving propensities of the former are considerably higher. Again, in LDCs, developmental expenditure is often pruned due to the shortage of financial resources.
  2. In spite of this, deficit financing is inevitable in LDCs.
  3. Deficit financing for developmental purpose is resorted to mainly because, when the government in an underdeveloped country takes up the responsibility of promoting economic growth, it has to compensate for the lack of private investment through expansion of public sector. It is said that deficit financing tends to widen income inequality.
  4. Anyway, additional money thus created fuels the inflationary fire. However, everything depends on the magnitude of deficit financing and its phasing over the time horizon of development plan.

Further, deficit-led inflation tends to reduce consumption propensities of the public. Consequently, a rapid economic development will take place in these countries.

In developed countries, deficit financing is made to boost effective demand. But in LDCs, deficit financing is made for mobilization of savings.