Deficit Financing Meaning – Adverse Effects and Importance

deficit financing meaning

Deficit Financing Meaning and Effects

Deficit Financing Meaning – “Financing the gap between the government expenditure and government receipts”

In simple words, deficit financing deals with  meeting the gap that is created due to exceed in the government expenditure than its receipts. The government expenditure consist of both capital expenditure and revenue expenditure. Similarly, receipts consist of both revenue receipts and capital receipts.

Capital Expenditure is concern with acquisition of fixed assets such as land, building, machinery, equipment, etc. Revenue Expenditure on the other hand concerns with the expenditure incur on running the various government departments and providing various services.

Capital receipts are those receipts that the government earn from selling its fixed assets. These results in decreasing the assets of the government. On the contrary, revenue receipts are those receipts that the government earns from various government department such as taxes, interest ad dividend on various investments. These receipts do not results in creating any assets or reducing any liabilities.

Deficit Financing Effects

In order to understand the deficit financing meaning more clearly, it is also very important to know the effect of the same.

The most adverse effect of the deficit financing is that, the inflation rises up in the country. This is because as the aggregate expenditure increases, automatically the aggregate demand increase. In this case, people are even willing to pay higher for acquiring a good or services. This ultimately results in rise in the price levels in the country. And if the government is unable in controlling the inflation for a longer time, then it even is self defeating for the entire economy.

Second most disturbing impact of deficit financing is the inequality in the income distribution. As the inflation rises, the, the supply of the goods and services falls. In this case only those can buy the goods and services who are rich and wealthy. The poor section of society becomes more poorer. However, if the money is spent on public welfare purpose, then it could help in achieving the equality in some extent.

The investment pattern of the investors also changes when inflation arises due to deficit financing. They go for those investment avenues which profit quick profits. From the economic point of view, this is not a good sign for the economy of that country.

Even with the deficit financing, the countries have the money, but they are unable in creating employment opportunities for their residents. This problem becomes more worse in low developing countries where even finance is available but do not have enough resources.

With the rise in the inflation, interest rates on returns also decreases. This results in flight of capital to foreign countries in hope of better and safe return.

Importance of Deficit Financing

This is the most safest source of getting money for the government. If government will try to increase the burden of the tax payer, then it either receive the protest or have to loose its popularity. So deficit financing does not results in taking money from anyone, also the development is also achieved.

Deficit financing is mostly done in India by taking loans from Reserve Bank of India. This means that in future government has to pay the interest on loans. Well this interest comes back to the government in the form of profits. However, if government borrows from some other country, then it has to pay the interest.

Deficit financing is known for its inflationary nature of financing. It is said that, a small amount of inflation is always good for an economy. The ideal inflation rate is 4%+ 2% or 4% – 2%. However, if the inflation rate has significantly risen up, then it is matter of serious concern.

Related Financial Terms of Deficit Financing

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