Deficit financing (Meaning and Significance), Budget (Meaning and Components)

Deficit Financing

Deficit financing has emerged as an important tool of financing the government expenditure. In simple words, it means as filling a gap caused by the excess of the government expenditure over its receipts through the creation of new money.

The term deficit financing is used to denote the direct addition to gross national expenditures through budget deficits, whether the deficits lie on revenue or of the capital account. There are mainly three techniques of deficit financing. They are:

1. Borrowing from central bank
2. Withdrawal of its cash balances from the central bank
3. Issuing of new currency, i.e. printing of more notes and putting into circulation

Objectives of deficit financing

1. The deficit financing is a method of meeting the financial needs of the government during crisis period such as war because the government tends to resort to acquire a quick command over resources to meet the growing war expenses.
2. It is advocated as a tool for economic development, output, and employment.
3. It is advocated for the mobilization of surplus, idle and unutilized resources for promoting rapid economic growth in underdeveloped economies as well as developing economies.
4. It is advocated as essential to mobilize resources for financing the plans.
5. To raise the level of effective demand and stimulate private investment.
6. To accelerate economy with high employment and economic growth.

Role of deficit financing

1. Deficit financing and war expenditure 

During the war period, it becomes difficult for the government to finance the war expenditure through its normal methods. In fact, it curtails other uses of various goods and services. The rise in prices takes place because, on one hand, increased purchasing power is injected into the economy through war purchases and on the other hand, the resources are mobilized from the general public not for increasing the production or raising the productive capacity of the economy but simply for throwing into the war effort. Deficit financing leads to inflationary pressure on the economy unnecessarily.

2. Deficit financing and depression 

During the depression, there is a fall in effective demand and this fall is accentuated by falling employment. Deficiency in demand leads to unemployment. Adopting deficit financing, additional money created may increase the total spendable funds which in turn push the total demand and employment in the economy.

3. Deficit financing and price level 

It is admitted that deficit financing leads to inflationary trends in prices. It is because there is more purchasing power in the hands of the people with the increase in expenditure of the government. In every sense, it is referred to the increase in the expenditure which leads to a rise in price level.

4. Deficit financing and employment 

JM Keynes advocated deficit financing as an important tool for solving the problem of involuntary employment in developing countries in the period of depression and recession. It implies that conditions of unemployment can be removed to a greater extent by increasing the effective demand. The program of public expenditure financed through deficit financing will increase the purchasing power in the hands of public resulting in the raising of the effective demand. As Keynes suggested, the increase in investment and the successive reinvestment of the new income will give rise to the multiplier effect. This will lead to an increase in the employment and level of income.

5. Deficit financing and distribution of income 

It is commonly believed that deficit financing tends to produce an unhealthy effect on the distribution of income, and instead of filling the gap between rich and poor, the gulf of inequality widens continuously. The real income of the wage-earning class declines and rising prices lead to the distribution of wealth in favor of profiteer class. In this way, resorting to heavy deficit financing is dangerous for the attainment of social objectives of planning such as equal distribution of income and wealth, improvement in the standard of living.

To conclude deficit financing for financing development activities is not only useful but assumes vital importance for the developing economies and the principle of smoothness with stability should always be preferred to the principle of unbalanced growth.

Budget

A budget is an estimate of government expenditures and revenues for a fiscal year, usually presented to the parliament by the finance minister. In Nepal, the budget is submitted to the parliament by the finance minister in the month of Ashadh each fiscal year. It is a financial document containing a preliminary approval of estimates of government expenditures and revenues. In other words, the estimated statement of the government’s revenues and expenditures is called budget. In short,

• The budget is a proposed statement which is prepared by the government of a nation and is presented to the parliament.
• It is a statement of the government that contains proposed expenditures and expected revenues of the government for the current fiscal year.
• It contains the actual figures of the government revenues and expenditures of the previous fiscal year and also, if necessary, the revised estimates of expenditures and revenues of the current fiscal year. Thus, the budget contains elements of flexibility.

Objectives of budget

The objectives of budget differ from country to country depending upon the economic conditions of the country’s economy. Some important objectives of the budget can be put as follows:

1. Collection of more revenue
2. Control of government expenditure
3. Optimum allocation of resources
4. Providing information to the people concerning the expenditure and revenues of the government.

Components of budget

The main components of a budget are discussed below:

i. Actual report of previous year
A good budget should include the total amount of revenue and expenditure of previous fiscal year.

ii. Actual planning for current year
The budget should analyze the past trend of income and expenditure in order to determine a realistic amount of revenue and expenditure in the budget of current fiscal year.

iii. Estimate of budget for future
The budget should also contain the estimate of sources of revenue and heads of expenditure for the coming fiscal year.

iv. Proposals of new tax rates
The budget must contain the proposals of new taxes change in existing tax rates if it is necessary to implement in the economy in that fiscal year.

Reference

Bernake and Abel, Macroeconomics, Singapore, Pearson Education latest edition