What is Government Borrowing or Debt Financing of Budget Deficit ?

What is Government Borrowing or Debt Financing of Budget Deficit ?

Government borrowing is a fiscal method used by the government to mobilise savings of the community for economic development of the country.

In the present time, government borrowing have become necessary because taxation alone cannot provide adequate funds for economic development and also heavy taxation has an adverse effect on private investment and saving.

When there is fiscal deficit (budget deficit) it can be financed in two ways.

(a) Debt Financing of Budget Deficit –

When government borrows from the market it is called debt financing of budget deficit. This also leads to the increase in public debt.

(b) Money Financing of Fiscal Deficit (Budget Deficit) –

When government finances deficit by printing new money it is called money financing of fiscal deficit (budget deficit).

(a) Debt Financing of Budget Deficit –

Government finances budget deficit by issuing bonds and selling them to the public. Generally, sale of interest bearing bonds to the public is indirect through the financial institutions such as banks. Banks buy the bonds from the government with the currency deposits of the public. Therefore, debt financing of budget deficit is also known as bond financing of budget deficit. With the borrowed money government expands its expenditure which helps in economic development.

The Keynesians have emphasised the expansionary effect of debt financing of government expenditure or budget deficit. In the Keynesian model with a fixed price level, the increase in government expenditure by the use of borrowed money causes an upward shift in aggregate expenditure (C+I+G) curve. If the economy is working at less than full employment level of national output, then the increase in debt financed government expenditure will expand the output or income. With the increase in the income at a given tax rate, tax revenue collected will rise which will over time reduce the budget deficit or even ultimately eliminate it (means budget becomes balanced).

With overall increase in the national output or income interest rates also rises but it does not fully offset the expansionary effect of debt financed increase in the government expenditure. Therefore, there is net expansionary effect of debt financed increase in government expenditure.