Public Economics cont.

pt2
Consequences of government expenditure

• As a result of government expenditures being too high, government will have to take loans to cover the
budget deficit. This will limit the funds available for the private sector to take as loans and as well as it
will limit private sector investments due to the increase in interest rates. This phenomena is called as
“the crowding out effect”
• Negative effect over the BOP when government finance budget via foreign sources
• Large amount of government capital expenditures will result in future economic growth for the country
• Tendency of having high government debt burden as a result of excess gov. expenditure
• High current expenditures will create a negative impact on current account and overall balances
Government budget
• Appropriation Bill – This is basically the gov. budget proposal before the approval of the parliament. This
includes the expenditures and revenue under each department . This bill is presented to the parliament 3 times
(3 readings). After getting majority votes and approved by the parliament this is known as appropriation act.

• Supplementary estimate – If a certain ministry needs more money after the approval of the appropriation bill,
the relevant minister presents an estimate to the parliament. This is called supplementary estimate.

• Vote on account – In an unexpected situation such as war, election or natural disasters, it is difficult to present
appropriation bill to the parliament at the right time. Therefore, a temporary schedule is presented to pay the
expenditures for the next financial year. (Only includes expenditures, no new policies or projects.)

• Interim budget – In a situation where a budget is already approved by one government, due to the appointment
of a new government, a new budget is presented with amendments for the existing budget. This is known as
the interim budget.
Difference between personal budget and gov. budget
• A personal budget mentions the revenue sources first and then plan for the expenditures, but
government budget first estimates the expenditures and then decides ways to meet those expenses.

• There are three main budgetary concepts,

1. Deficit budget – exp revenue

2. Surplus budget – revenue exp

3. Balanced budget – revenue exp

*effect on AD and output

• Current Account – account capturing government revenue and current expenditure (This does not capture grants)

Current A/C balance = Total revenue except grants – current expenditures

• Primary Account - Difference between total gov. revenue and grands and total gov. expenditure except interest
payments

Primary A/C balance = total revenue and grants – total expenditure except interest payments

• Overall Balance – Difference between gov. revenue and grants and total gov. expenditure

Overall A/C balance = Total revenue and grants – total expenditure

• Net cash deficit = difference between total gov. revenue and grants and total expenditure excluding,

1. Sinking funds Net cash deficit = overall balance – payment of debt installments

2. Direct payments of public debt *Overall balance without loan repayments

3. Subscriptions to int. financial orgs.

There are 2 types of budgetary policies -
• Expansionary budgetary policy –

Expansionary policy is where the government expenditures increases resulting in a obtaining government debt.
Therefore, the money supply and the inflation of the economy increases. (the aggregate expenditures exceed
aggregate revenue resulting inflation)

This happens only when the government borrows money from central bank and commercial banks

• Contractionary budgetary policy -

Contractionary policy is where money supply does not increase due to government debt obtained to fulfill the
budget deficit.

This happens when government borrow money from other sources like, EPF, specialized banks etc.
Deficit Financing
When expenditures exceed revenue, there are various sources governments use to finance this deficit.

Ways of deficit financing

Domestic debt Foreign debt

Market Non Market- deposits/surpluses from gov. inst. Project loans non project loans

Banking sector (CBSL, KBs) – inflationary, money creation

Non banking sector (NSB, EPF,ETF, Insurance companies) – non inflationary, no money creation

Banking sector- money raising through CBSL has a dual impact on Money supply,

The CBSL finance the fiscal deficit through issuing new currency. Therefore,

1st impact – New currency increase currency circulation

2nd impact – when they are injected to the KBs money supply again increase due to credit creation
• Does both deficit financing from banking and non banking sources creates crowding out effect?

YES!

Crowding Out Effect – private investors are losing opportunity to get funds for their investments since gov. is
absorbing funds to finance budget deficit. The effect gets worse to private investors looking for funds because
of increasing in interest rates in the market due to this excessive fund demand.

Non market sector – gov. deposits and surpluses,

• PL 480 fund, widows and orphans fund, departmental savings, treasury deposits

Economic effects of deficit financing from domestic sources -

1. Crowding out effect

2. Creates inflation and expansion in money supply

3. Increase in interest rates

4. Difficult to manage fiscal financials

Foreign Debt –

Project loans – taken for a specific project

Southern highway from Asian Development Bank

Maththala Airport from China

Non project loans – no such specific project. Money is not allocated to one specific thing

There are two main foreign sources –

1. Foreign loans
• Concessionary – lower/no conditions and lower interest rates, longer payback period
• Non concessionary – high interest rates and under lot of conditions

2. Foreign Grants – Received in form of a donation. Does not have to pay back at all
Economic consequences of foreign debt –

1. Crowding out effect will not take place

2. Negative impacts on diplomatic relations and international trust

3. Negative impact on external value of local currency ( exchange rate)

4. Will have to face international debt crisis

Look in to the figures in the bank report and look for trends and patterns in debt and debt repayment