Effects of Public Borrowing:

Public borrowing involves transfer of purchasing power from individual to

government and a subsequent retransfer of the same to the individuals from the
government. Thus, public debt, in one sense, has the ‘revenue effect’, and, in another
sense, has the ‘expenditure effect’. This means that public borrowing produces
different effects on the economy. However, the exact effects of borrowing will greatly
depend on the sources of borrowed amounts.

i. Effect on National Income and Distribution:

It is said that the net effect of government borrowing is expansionary. If loans are
raised for productive purposes, scarce resources may be distributed rationally. In other
words, resource allocation will take place to sub-serve national interests.
Consequently, national income will rise.
But if loans are raised to finance unproductive activities like repayment of loans,
resources then may not be allocated in an optimal manner. Even then, the effect of
public borrowing on consumption spending is likely to be less adverse. Again, public
borrowing does not produce any significant adverse effect on investment. Thus, public
borrowing can produce favorable multiplier effect on national income.
Often government imposes taxes to finance its loan repayment programme. High rate
of taxes discourages people to work more. Although public borrowing involves
transfer of resources (from taxpayers to the lenders), the negative effect of taxes (i.e.,
desire to work less when taxes are increased) produce an unfavourable effect on
income.
Because of debt, present generation obtains less capital. Thus public borrowing is not
necessarily expansionary. A lower volume of capital reduces production and
productivity of an economy.
It is alleged that public borrowing widens income inequality. As far as loan repayment
is concerned, government levies taxes whose burdens are felt more or less by all—both
rich and poor. However, burden of taxes is mostly felt by the poor people.
Rich people who lend money to the government earns more interest income than what
they sacrifice by paying taxes. Hence inequality widens. However, poor people will be
benefited through borrowing programme if the borrowed amounts are spent for their
uplift. Only then, inequality will lessen to some extent.
ii. Effect on Price Level:
Whether public borrowing is anti-deflationary or anti- inflationary depends on how the
debt affects the money supply and how it affects economic activity. Loans from banks
(say purchase of government bonds by commercial banks) lead to an increase in
money supply. This will put a great pressure on the price level. In this sense,
‘borrowing is inflationary’.
However, public debt is not necessarily inflationary in character. If public debt is used
to raise income, employment and output, the inflationary effect will then be greatly
minimized. But inflation, under the circumstance, is unavoidable.