Question

When is a financing via budget deficits are justified?

Answer 1

Deficit financing, a process in which a government spends more money than it collects as revenue, making up the difference by borrowing or minting new funds. Although budget deficits can arise for several reasons, the term generally refers to a deliberate effort to stimulate the economy by reducing tax levels or increasing government spending. The impact of government deficits can be very high on a national economy. It is generally accepted that the old vision of an annually balanced budget will be replaced by a budget balanced over the course of a business cycle

But deficit financing may also arise from government inefficiency, indicating widespread tax avoidance or excessive expenditure rather than a planned countercyclical policy activity.

Where capital markets are undeveloped, deficit financing can position foreign creditors in debt to the Government. Therefore, budget surpluses can be attractive in many less developed countries as a way of promoting private savings in themselves.

In general, debt funding has been thought to be necessary where the tax burden of current financing would be technically or politically infeasible for such circumstances; examples are major capital projects such as highways, hospitals, etc., for national governments, battle, and for local governments. Public debt rates vary from country to country, from less than 10 per cent of GNP to more than double GNP. Public borrowing is commonly thought to have an inflationary effect on the economy, which is why consumption, expenditure, and jobs are frequently resorted to in recessionary periods.