Deficit financing is the term used in the context of government financing. We all know that governments all over the world receive money in the form of direct and indirect taxation and spend this money to take care of basic or civic amenities of people like food, shelter, hospitals, roads, and other infrastructure facilities but sometimes government spends more money than it receives from the tax receipts and this is nothing but deficit financing. In order to get a better idea about this concept one should look at some of the advantages and disadvantages of deficit financing –
Advantages of Deficit Financing
Multiplier Effect on the Economy
The first and foremost advantage of deficit financing is that it leads to a multiplier effect on the economy in the sense that when the government spends money on infrastructure it trickles down to every section of society which in turn leads to increased economic activity and seeing the improvement in economic activity even private sector and multinational companies increase their investment in the country which magnifies the impact of the deficit financing.
Only Alternative for Government
Another benefit of deficit financing is that it is the only alternative which is available to the government especially in the case of developing nations because if they stop deficit financing that it can lead to revolution and resentment among the people of the country as in the absence of deficit financing government will not be able to satisfy even the basic needs of people which we all know is an explosive situation. In simple words just like oxygen is needed for a person battling for life in the same way deficit financing is important for a developing country battling with problems of poverty, unemployment, and economic turmoil.
Economic Growth
If the country is facing recession or is in a low economic growth trajectory then deficit financing can be a good tool for putting the economy back on track as far as economic growth is concerned. In simple words apart from using interest rates reduction by the central bank government can also use deficit financing in order to stimulate the economy and put it out of the jaws of recession.
Disadvantages of Deficit Financing
Inflation
The biggest drawback of deficit financing is that it leads to inflation because in the case of deficit financing the government is borrowing and putting the funds into an economy which raises the risk of demand-side inflation as the supply of goods is fixed and we all know that inflation can turn to be a big problem going forward for the economy. In simple words, the government has to do a tradeoff between using deficit financing and tackling the inflation problem.
Creeping of Indiscipline
Another problem with deficit financing is that sometimes it can lead to indiscipline in the government in the sense that it allows the government to spend more than the revenue it has earned and thus government does not have to worry about overspending as well as non-collection of tax revenues as they know they can get away with deficit financing. In simple words, if you give a person 100 dollars and tell him that he will have to give you a summary of all expenses done but if you tell him that there is no need for giving any summary and you will give more dollars in case he is left with no money than that person will spend the money recklessly without thinking about anything the same thing happens with deficit financing as the government has a free hand with respect to its spending thus can be a big problem in case of those government’s which are indiscipline and inefficient.
Vote Bank Politics
Vote bank politics is another major limitation of deficit financing because when elections are near the governments in order to please the masses give subsidies and tax relief which economically may not be the correct thing to do but due to political motives, governments do these things thus putting great pressure on governments future balance sheet.
As one can see from the above that deficit financing has pros as well as cons and that is the reason why any government thinking of using deficit financing as a way of tackling the economic problem should carefully read the above points and then only should take any decision as deficit financing is a double-edged sword and should be used with caution.