Question

The state of Georgia is considering the construction of a high-speed rail system to alleviate traffic congestion, especially across the Atlanta Metropolis at a cost of $45 billion. Some of the funding will come from the Deutsche Bank financial institution, while most of it will be through the issuance of state bonds, with the rest financed by private investors who will own shares in the rail system. Explain how financial intermediation is necessary to make this project a reality. Why couldn’t the state use the tax revenues it collects during the current year to pay for it?

Answer 1

A brief discussion on the question will be provided in the Explanation section as follow:

Explanation:

Financial intermediaries such as the banks will have the large reserves mainly from the investors who have deposited in their account. These reserves will be used to lend out to various lenders including the government. Therefore, Deutsche Bank in this case will be buying the government's bonds to provide borrowing to the government. The rest of the funding will come from the private investors who will invest in the rail project. There are reasons for this.

Government will be able to reduce to the financial burden that that it may encounter for using significant portion of tax revenue collected. Large chunk of tax revenue will be tied in the rail project. This will restrict the amount available for government spending in other crucial areas such as education and healthcare. Thus, there can be higher opportunity cost of spending the large chunk from the tax revenue.

Thus, the government will need to partially finance the rail project with the investments from the private investors who will pool their resources to build the rail project. This will reduce the burden on the government.