15

DEFICIT FINANCING
"The term deficit financing is used to denote the direct addition to
gross national expenditure through budget deficit when the deficits
the capitalaccount,"
are on revenue or -Indian Planning Commission
Introduction
In ancient period there were neither deficit budgets nor any deficit
financing. The state expenditure was confined to the then available
6nancial resources of the state. The theory to cut one's coat according
to one's cloth existed. The state expenditure was confined to civil
administration and defence of the country against foreign invasion.
HOwever, now the position has absolutely changed. The modern state is
awelfare state. Besides civil administration and defence it has to incur
heaw expenditure on the welfare programmes, such as, social insurance,
subsidies. unemployment allowance, free medical aid, free education,
child welfare, labour welfare, supply of water, electricity and gas etc.
concessional rates. Thus, there is a rapid increase in state expenditure.
The state expenditure exceeds revenue income. Now in order to meet
the increasing gap between expenditure and revenue income two
alternatives are available with the state: i) to increase the revenue
income by increasing taxation and imposing fresh taxes, (i) deficit
financing. The scope of first alternative is limited because (i) there is a
limit to it, and (ii) the state might have to face severe opposition of the
public. Under these circumnstances the state has to resort to the second
into
alternative, i.e., deficit financing. Deficit financing came
prominence in 1936 with the evolution and spread of Keynes philosophy.
deficit financing has become the burning topic of the day. What to
Say of underdeveloped and developing countries, even developed countries
had to resort to deficit
financing.
MEANING AND DEFINITION OF DEFICIT FINANCING
mean Ihe
anyterm deficit financing
government or deficit
Cxpenditure whichspending' is generally
is in excess use t
of its current
revenue. However, 'deficit financing carries different
the term
Olauons in the western countries inchding U.S.A. and in Inaia.
WeslCrn countries inchuding US Adeficit financing implies an excess
234 | Public Finance
government ovcr its current revenue. Thc
of expenditureincurred by the could be financing either through public
deficit in the budget soincurred of new currency (issuing of fresh
borrowings or through the creation
currency) by the government. BothSharma, the methods would result in deficit
According to Dr K. K. "In western countries deficit
financing. of expenditure by Government,
financing is and referred to excess
capital expenditurce over revenue receipts even if it is covered
including loans." But in India, the term deficit
by receipts obtaincd through
interpreted in anarrower sense. Deficit financing in Indian
financing' is budgetary deficit is financed by the
sense may be said to occur when the
additional currency. Thus
government through the creation of new or term 'deficit financing' the
according to the Indian interpretation of the are not treated as deficit
borrowings of the governmnent from the public raised out of the
financing. The reason being that the public loans are in the transfer of
genuine savings of the public and they result merely the government
purchasing power from the hands of the public to
without adding anything to the total money supply of the community. The
deficit financing in India has been defined by Indian Planning
Commission as, the term deficit financing is used to denote the direct
addition to the gross national expenditure through budget deficits
whether the deficits are on revenue or capital accounts." In short, deficit
financing in the Indian sense involves the creation of new purchasing, i.e.,
issue of fresh currency by the government in order to meet the budget
deficit.
OBJECTIVES OR PURPOSES OF DEFICIT FINANCING
The main objectives or purposes of deficit financing are as follows:
(1) To Finance War Expenditure. Nowadays war is considered as
the most costly affair. When the financial resources raised through
taxation and public borrowings etc. do not suffice to meet the cost of war,
the government of a country has no other
alternative except to resort to
deficit financing to raise the necessary financial
of the war. During the First and resources for the success
Second World Wars, most of the
governments resorted to deficit financing as an effective method of war
finance. It results in the inflationary spiral and may play havoc with the
country's economy and may ultimately
Therefore, it is suggested that it shouldleadbe
to its complete ruination.
the last and not the first
method to be followed for financing war.
(2) To Promote
financing has also been Economic Development. The use of deficit
considered essential for promoting economic
development mainly in the
Certain social, cconomic andunderdeveloped and developing countries.
these economies. institutional factors work as obstacles in
Underutilisation
backward state of technology, of
absence
natural resources, lack of capital,
of modern
institutional deficiencies and other enterprise, colonialism,
country poorer. The private
undertake the' challenges forinvestment
non-economic causes
is inadequate and keep a poor
economic development. The unable to
fiscal
 Deficit Financing | 235
apparatus of these cconomies is not so clficicnt as to
raise the sufficicnt
revenuc resources for the cconomic development. For instance,
additional taxation, in these countrics, had a very narrow base on account
of the universal poverty of the people. Similarly,
source of public borrowings, as a
finance, had a limited scope on account of low incomes and
high marginal propensity to consume of the people. Morcover, most of
the underdevelopcdand developing countries had a democratic political
set-up. Therefore, there is limited scope of additional taxation on
political grounds. Under these circumstances, the governments of under
developed and developing countries, therefore, found it more expedient
to raise additional financial resources through deficit financing, i.e.,
printing more paper currency. Further, deficit financing, as a methodof
finance, arouses little opposition from the public. That is why India too
took shelter under deficit financing for financing its Five Year Plans.
(3) To Uplift the Economy out of Depression. Prof. J. M. Keynes
advocated the use of deficit financing as an instrument of economic
policy to uplift the economy out of the depth of economic depression and
also to raise the level of output and employnent. At such a time, private
investment becomes slack on account of the allround pessimism in the
economy. Prof. J. M. Keynes looked upon public investment as an effective
antidote to declining private investmnent during depression. Public
spending would result in an increase in output, employment and income.
Deficit financing or rather deficit spending as the term used by Prof. J. M.
Keynes is the only way to come out of depression and to raise the level of
output andemployment.
(4) Mobilisation of Surplus, Idle and Unutilised Resources in the
Economy. Deficit financing is also advocated as an instrument for the
mobilisation of surplus, idle and unutilised resources in the economy of a
country. They remain inactive unless the additional purchasing power is
created in the economy and skillfuly used as a positive means of
mobilising the surplus, idle and unutilised resources in the economy. No
one can deny the fact that deficit financing is an effective instrument for
mobilising the surplus, idle and unutilised resources in the economy of a
country. It is more true in case of an underdeveloped anddeveloping
country.
(5) To Prevent Unenmployment. What to say of underdeveloped and
developing countries even developed countries are facing the chronic
problem of unemployment. According to Prof. J. M. Keynes, the only
remedy of eradication of unemployment is the deficit financing. The
period of depression is responsible for unemployment because there is
considerable reduction in cffective demand during this period. Prof. J. M.
Keynes gave the theory of public spending during depression period. It
was a sort of deficit spending on the part of the state which could
ultimately raise the level of income, output and employment manitold
through the interaction of the multiplier process given below:
 EFFECTS OF DEFICIT FINANCING
OR
CONSEQUENCES OF DEFICIT FINANCING
Deficit financing involves an expansion of currency created either
by the banks which expand credit or by the government in the form of
issue of fresh currency. No doubt that deficit financing helps in increasing
 Deficit Financing | 237
the pace of economic development in underdevelopcd and
countries, but some of its other developing
conscqucnces may sometimes of
expectations of the planners. The elfects or conscquenccs upsct the
deficit
financing may be studicd under the following hcads :
(1) Effects of Deficit Financing on Price Level. The immediate
effect of deficit financing is a sharp rise in general price levcl of the
country. Through the creation of new money, deficit financing results in
an increase in the aggregate monetary demand for the existing supply of
goods and services in the community. While aggregate monetary demand
increases consequent upon deficit financing, the supply of goods and
services in the community does not increase in the same proportion. This
produces the inevitable inflationary gap in the economy of a country,
causing prices to rise to higher levels. This happens particularly at the
time of war, when the money supply in the economy rises at an
extraordinarily fast rate, while the available supply of goods and services
for civilian consumption actually registers a fall, causing severe scarcity
conditions in the economy. The rise in the price level in wartime economy
may be in aproportion grcater than that warranted by the increase in the
supply of newly created money by the central bank/government. Thus
deficit financing, during war, results in an inflationary spiral which
increases the general price level at an extraordinarily fast rate. It is also
evident from severe rise in price level in India during First and Second
World Wars.
It is argued that deficit financing for development is quite different
from that undertaken for financing a war. In the latter case, there is extra
expenditure without any increase in the output of wealth, and therefore
inflation is inevitable. On the contrary, deficit financing for development
increases the production of goods and services in the future and its
inflationaryeffect is,thercfore, neutralised by the increase in output, i.e.,
goods and services.But the increase in production would be only after a
ime lag, and the longer the time the project takes in maturing, the longer
is the time lag between the increase in demand and increase in supply.
Moreover, inflation provides incentive for increased private investment.
As prices rise, profitability of private investment increases and that
encourages further investment. Thus deficit financing is a peacetime
developing economy and may not, thcrefore, be considered as unsafe and
dangerous as in a wartime economy.
(2) Increase in Money Supply. Deficit inancing results in the direct
addition to gross national expenditurc or in the creation of fresh
purchasing power in the hands of the government. It results in expansion
of moncy supply in circulation as a result of deficit financing.
(3) Effects of Deficit Financing on Employment. Prof. J. M. Keynes
advocated the use of deficit financing as a means of climinating mass
uncmployment in a devcloped country during depressed cconomy.
According to Prof. J. M. Keynes, the main cause of unemployment in a
developed country is the deficiency of effective demand, i.e, the demand
238 | Public Finance
effective demand
of consumption goods and investment goods. The for increasing
depends upon the marginal propensity to consume.of Thus,
unemplcyment in
the effective demand and removing the conditions
of depression, Prof. J. M. Keynes
developed economies during the period public
advocated deficit financing to finance works projects. This will
hands of the public. Hence, the
increase purchasing power in the will further increase
effective demand will thus be increased. This
employment which again will increase called effective demand and, hence
employment and so on. Prof. .J. M. Keynes it 'multiplier effect'. That
particularly U.K. and the U.S.A.
is why several devcloped countries, depression of 1930'stodeal
resorted to deficit financing during the great
with the problem of mass unemployment. countries, as the
But this does not hold good in underdeveloped are not found true to
assumptions, on which Keynes' analysis is based idle and
underdeveloped countries. They are as follows : (i)Existence ofSupply of
unutilised capacity in industrial and agricultural sectors. (ii)
working capital is relatively elastic. (ii) The multiplier concept does not
account` of the lack of
hold good in underdeveloped countries on
entrepreneurship, technical know-how etc. (iv) There is long-term
capital resources
chronic unemployment.(v) There is chronic shortage ofdeficit
Thus, financing is
in relation to the rapidly incrcasing population. in underdeveloped
helpless in removing the conditions of unemployment in
countries. Even then if an attempt is made to liquidate unemployment
technique of
an underdeveloped cconomy through the application ofit the may plunge the
deficit financing, far from eliminating unemployment, inelasticity of the
country into an inflationary spiral on account of the
supply curve of output.
(4) Deficit Financing and Capital Formation. If deficit financing is
development of a country, it
applied according to the needs of economiccapital
increases capital formation. We know that formation is one of the
underdeveloped and
basic conditions for the economic development of the following
developing countries. Deficit financing increases capital inprofits during
ways : Firstly, industrialists and businessmen earn huge
inflation period. Since this section of the society possesses high saving
demand of
tendency, it increases capital formation. Secondly the increase in their
consumer goods is likely to reduce on account of rapid
industries to
prices. It may divert some resources from consumer goods
capital goods industries. It may also lead to capital formation. Thirdly
deficit financing may prove helpful in making the best use of idle,
unutilised and surplus resources in the economy. Thus, deficit financing
can be used as an effective instrument for increasing production. This
may also lead to capital formation.
(5) Deficit Financing and Distribution of Income. Deficit financing
affects adversely the distribution of income. Generally, it is considered
that the deficit financing is potentially inflationary in character. On one
side the industrialists and businessmen earn huge profits during inflation
 Deficit Financing | 239
period. On the contrary, labourers and fxed income groups suffer on
account of the sharp reduction in the purchasing power of their
hard-earned money during inflation period on account of the rise in price
level. Thus, the disparity of incomes increases as the rich become more
rich and the poor become more poor.
DOI ORnUEIIT RNANINC IN PROMOTING ECONOMI