What are your views on the funding of the deficit by market borrowings? How banks indirectly finance the same, and the effect of commercial lending?

2 Answers | Add Yours

pohnpei397's profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted on

I assume you are talking about funding a government deficit.

If so, I think that market borrowing is the best possible way for a government to fund a deficit (if it really has to run a deficit).  The only other way to fund a deficit that I can think of would be to print money and that would cause more inflation than borrowing on the open market would.

Of course, a deficit that is too high has be effects.  Money that goes to financing the government deficit cannot be borrowed by private borrowers.  In addition, the added competition to borrow money will cause interest rates to increase.

krishna-agrawala's profile pic

krishna-agrawala | College Teacher | (Level 3) Valedictorian

Posted on

We can classify all the sources of funds for government spending in three groups. Taxation, borrowings, and issue of currency. The borrowings can be further classified as borrowing from domestic sources and from foreign sources.

Taxation has the effect of reducing the disposable income in hands of the people for private spending and investments. Borrowing from domestic sources including from local banks directs private disposable income towards saving, which may be used later for consumption or for investment. But in long term the government has to repay the amount borrowed along with interest. In a economy that is growing this becomes relatively easier.

Borrowing from external sources, increases the total increases the total domestic spending in private plus government sector. This tends to create inflationary pressure in the domestic economy. Plus the government has to repay the external debt with interest at a later date. Issue of currency or printing of money has the maximum inflationary pressure in the economy. In this case the government increases the spending beyond available resource. But the government is not required to repay the amount. Therefor there is no long term liability.

Based on the impact of the different sources of government funding, as described above, I believe the best approach will be keep the deficit low. The most preferred source of financing this deficit is domestic borrowings. Borrowings from external sources is not very desirable, but may become avoidable in case enough foreign exchange is not available for imports. Printing of money is the least desirable method of funding deficit because it can lead a tendency to spend beyond the means of the economy leading to unmanageable inflation.

Borrowings from banks are also a form of commercial borrowings. The borrowing of banks indirectly represents borrowing for the general public and other institutions as most of the loans by banks are funded by deposits they receive from others.

We’ve answered 318,917 questions. We can answer yours, too.

Ask a question