Deficit financing means developing funds to finance the deficit which results from excess of expenditure over revenue. The gap is covered by borrowing from the public by the sale of bonds or by printing new money.
Importance of deficit financing:
For developing countries like India, higher economic growth is a highly important. A higher economic growth requires finances. With the private sector being shy of making huge expenditures, the responsibility of drawing financial resources rests on the government.
Often both the tax and non-tax revenues fail to mobilize enough resources just through taxes. The deficit is often funded through borrowings or printing new currency notes.
What are the pitfalls of deficit financing
Printing new currency notes increases the flow of money in the economy. This leads to increase in inflationary pressures which leads to a rise of prices of goods and services in the country. Deficit financing is inherently inflationary. Since deficit financing raises aggregate expenditure and, hence, increases aggregate demand, the danger of inflation looms large.
What are the effects on investment?
Deficit financing effects investment adversely. When there is inflation in the economy employees demand higher wages to survive. If their demands are accepted it increases the cost of production which de-motivates the investors.
