3/11/2023 0 Comments Government and moneymoney![]() According to this view, due to crowding-out effect on private investment net expansionary effect of increase in government expenditure is negligible. Thus, debt-financed increase in government expenditure crowds out private investment. The rise in interest rate will cause private investment to decline. First, it has been pointed out that government’s borrowing funds to finance budget deficit will lead to the increase in demand for lendable funds which will cause the rate of interest to rise. The crowding-out effect on private investment takes place in a variety of ways. However critics have pointed out that debt-financed government expenditure is largely offset by the crowding-out effect of debt financing on private investment. ![]() This will bring about increase in tax revenue collected by the government and over time budget deficit will be Now, with debt-financed increase in government expenditure IS curve shift to the right from IS 0 to 75, with LM curve remaining the same. Initially, the equilibrium is at income level Y 0. ![]() Y* is the full-employment level of output. This can also be illustrated through JS-LM model in Figure 34.1 where IS and LM curves are drawn, given the money supply in the economy. With the increase in income at the given tax rate, tax revenue collected will rise which will over time reduce the budget deficit or even ultimately eliminate it so that budget becomes balanced. If the economy is working at less than full-employment level of national income so that output gap exists in the economy, the increase in debt-financed government expenditure will bring about expansion in output or income. In the Keynesian model with a fixed price level, the increase in government expenditure through use of borrowed money causes an upward shift in aggregate expenditure (C + I + G) curve. The Keynesians have emphasized the expansionary effect of debt financing of government expenditure or budget deficit. The government has not only to pay annually interest on borrowed funds but has to pay back also the principal sum borrowed for which it may levy higher taxes in future. This type of budget deficit can also be financed through incurring debt by selling bonds to the banks or public. It may also be noted that budget deficit also comes about when taxes are reduced, keeping government expenditure constant. With the borrowed money in this way the government is able to expand its expenditure but at the same time it adds to public debt which has both short-run and long run consequences. Therefore, debt-financing of budget deficit is also known as bond-finance of budget deficit. Banks buy the bonds floated by the government with the currency deposits of the public. Generally, sale of interest-bearing bonds to the public is indirect through financial intermediaries such as banks. Under debt-financing of fiscal deficit or borrowing the government issues bonds and sells it in the market. Borrowing or Debt-Financing of Fiscal Deficit : Second, budget or fiscal deficit can be financed by printing new money and therefore it is called money financing of fiscal deficit. Borrowing as a means to finance the fiscal deficit is therefore also called debt-financing of budget deficit. ![]() ![]() First, by borrowing by the Government from the market and this borrowing leads to the increase in public debt. It may noted that when there is fiscal deficit (i.e. ![]()
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