What is Money Financing of Budget Deficit ?

What is Money Financing of Budget Deficit ?

The government can finance it budget deficit by printing high powered money. The revenue raised through printing new money is also called Seigniorage. When government finances its budget deficit by printing new money, money supply in the economy increases which may cause inflation.

According to the Keynesian view, when money is increased in the times of depression or recession when both productive capacity and labour are lying idle due to deficiency of aggregate demand, price level is not likely to rise much and the effect of increase in money supply is to raise output or income. The increase in real income will increase revenue from taxation which will tend to reduce the budget deficit in the short run.

If the economy is operating at or near full employment, printing new money to finance the budget deficit will cause inflation. This is because when government prints new money it causes inflation and reduces the real value of money holding with the public.

{Value comes from Scarcity, when government prints money, it increases money in the economy which reduces the real value of money.}

In the Keynesian model with a fixed price level when the economy is in recession due to demand deficiency which causes a lot of unemployment of resources.

The tax function can be written as

T = t(Y)

T = Total Tax Revenue

t = rate of tax

Y = Real Income

If G is the government expenditure, then budget deficit can be written as

Budget Deficit (BD) = G – t(Y)

G = Government Expenditure

If G – t(Y) = 0, then budget deficit will be equal to zero.

If G – t(Y) > 0, then there will be budget deficit.