Lecture(8)

Chapter (3)
Public loans(continue)
 The effects of Fake public loans
-Fake loans (Issuing money) , leads to increase the
Money supply(Ms), as a result the interest rate(r)
will decrease, and that will lead to increase
investment(I) level, where there is negative
relationship between (r)&(I).
-On the other hand the increasing in investment
depends on the elasticity of demand curve on the
investment (If the demand less elastic the increase
in private investment will be limited).
-Fake loans (Ms) lead to AD(C + I + G + X-M) because:
A-If the Gov Ms   cash income   consumption
specially for poor and middle income.( AD)
B-If the Gov Ms   interest   Investment level. ( AD)

• The economic effect of fake debt on total output

and market price level will depend on elasticity
of as the following cases:
1-If the supply curve perfectly elastic (AS4), , fake
loans(MS) leads to Q (positive effect) without effect on
market price ( no negative effect) but this case unrealistic.

2-If the supply curve is elastic (AS3), , fake loans(MS) leads

to Q (positive effect) more than  in price level (negative
effect), So the net effect is positive.

3-If the supply curve is inelastic (AS2), , fake loans(MS)

leads to price level (negative effect) more than  in Q
(Positive effect), So the net effect is negative(inflationary).

4-If the supply curve is perfectly inelastic (AS1), , fake

loans(MS) leads to price level (negative effect) without
effect in Q (Positive effect), So the net effect is
negative(hyperinflation).
Although there are a lot of resources unused in
the developing countries but is not justified for
using fake borrowing to finance Gov
expenditure because, the total supply in these
countries is inelastic and the unused resources
are not active for participation in the production
and these resources need very high cost to be
ready for using in production.
 The effect of hyperinflation on the economy
-Hyperinflation in the economy leads to many
negative effects on the social equity and economic
growth as the following:-
1-The relative prices of exports increases and relative
prices of imports decreases, as a result the local export
will decreases and local demand on imports will
increase and that leads to deficit in the current account
of balance of payment.

2-The value of local currency decreases rapidly, for this

reason the individuals lose their trusts in the local
currency and put their saving in foreign currency.
3-There are many negative effects on social equity
where:
a-Individuals who are their money income fixed
(employees), achieve losses with inflation, because the
real income (purchasing power) of this group decreases.

b-Individuals who are their money income variable

(traders, importers….) will achieve gains from inflation,
because their real income increases.

c-some individuals don’t affect by inflation because the

real income don’t change , because the money income
of this group increase by the rate equals the rate of
increasing of the market prices.
 Effects of External public debt
-Generally the external debt adds new real
recourses to the economy especially from
foreign resources.
-In this type we must distinguish between two
stages :
1- Subscription of loan stage.

2- Payments of loans service stage.

 The first stage: subscriptions of loans
1-The effect on production possibility curve(PPC):
-The external debt increases the supply of foreign
currency in the economy and the economy ability
to produce and to consume will increase.

-Other things being equal the production

possibility curve shift up as a result of external
debt.
2- The effect on value of local currency
-Other things being equal , the increasing of the
supply of foreign currency will affect positively
on the value of local currency.

-The increasing of the foreign currency

participates of achieving stability of the
exchange rate of local currency.
 The second stage
payment of loans service
• The obligations of external public debt services
require transferring real resources from the
economy to other countries, not from sector to
another inside the same country, for that the
external debt is become more risky than internal
debt.
• The economic effects depends on the usage of
external debt, and here we must distinguish
between :
1: Gov. use the external loan to finance capital needs in the
economy, there are many positive effects expected, that
effects depends on:
A) The external borrowing is used to finance some projects
in the export sectors or in the import alternative sectors.
-The ability to export or produce local alternatives to imports
will increase.

-According to that, the Gov. can pay the loan obligations by

foreign currency, because the usage of the external debt
increases the supply of foreign currency (positive effect on
the economy).

-In reality using external debt in the export sector represent

the best way to use this kind of borrowing.
B) The external borrowing is used to finance some
infrastructure projects.
-The amount and quality of these services will
increase and will affect positively on other
productive sectors especially on the export sector.

-According to that, the usage of the external debt

will generate (indirectly) foreign resources could
be sufficient to finance the obligation (positive
effect on the economy).
2-Gov. use the external loan to finance current
expenditures(consumption usage) in the economy, there
are different effects such as:
A)The external debt can be used to imports essential
foods:

In the short run : the supply of food increases and the

market price of food decreases in the local markets
(positive effects on the social and economic aspects in
the society).

But in the long run : the problem will appear when the
government starts to pay the obligation (negative effect
and the loan will represent high burden to the future
generation).
B) The external debt can be used to pay the
obligations of the foreign loans that contracted in
the previous periods:
-In this case the external borrowing doesn’t add
new resources to the economy.

-In reality using the external debt by this way reflect

short run solution to debt problem, without using
effective solutions, and the problem will be very
complicated (negative effect lead to debt crises).