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    The Fiscal Deficit: Themes Economic Briefs

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    Virendra Pratap
    The document discusses the fiscal deficit, explaining that it is the difference between a government's total expenditures and total receipts excluding borrowing. It argues that a fiscal deficit does not necessarily lead to inflation and discusses several counterarguments. It also addresses whether a larger deficit increases interest payments, the impact of reducing deficits, and other related topics.

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    The Fiscal Deficit: Themes Economic Briefs

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    Virendra Pratap
    79 views2 pages
    The document discusses the fiscal deficit, explaining that it is the difference between a government's total expenditures and total receipts excluding borrowing. It argues that a fiscal deficit does not necessarily lead to inflation and discusses several counterarguments. It also addresses whether a larger deficit increases interest payments, the impact of reducing deficits, and other related topics.

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    DEFINING MEANING OF FISCAL DEFICIT IN REAL ECONOMIC WAY FOR BETTER UNDERSTAINDING

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    Fiscal Deficit

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    The document discusses the fiscal deficit, explaining that it is the difference between a government's total expenditures and total receipts excluding borrowing. It argues that a fiscal deficit does not necessarily lead to inflation and discusses several counterarguments. It also addresses whether a larger deficit increases interest payments, the impact of reducing deficits, and other related topics.

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    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    79 views2 pages

    The Fiscal Deficit: Themes Economic Briefs

    Uploaded by

    Virendra Pratap
    The document discusses the fiscal deficit, explaining that it is the difference between a government's total expenditures and total receipts excluding borrowing. It argues that a fiscal deficit does not necessarily lead to inflation and discusses several counterarguments. It also addresses whether a larger deficit increases interest payments, the impact of reducing deficits, and other related topics.

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    Download as PDF, TXT or read online from Scribd
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    MacroScan (Printable Version) - Fiscal Deficit

    Page 1 of 2

    Themes > Economic Briefs

    The Fiscal Deficit


    Jyotirmoy Bhattacharya

    What exactly is the Fiscal Deficit? The fiscal deficit is the difference between the government's total expenditure and its total receipts (excluding borrowing). The elements of the fiscal deficit are (a) the revenue deficit, which is the difference between the governments current (or revenue) expenditure and total current receipts (that is, excluding borrowing) and (b) capital expenditure. The fiscal deficit can be financed by borrowing from the Reserve Bank of India (which is also called deficit financing or money creation) and market borrowing (from the money market, that is mainly from banks). Does a Fiscal Deficit Necessarily Lead to Inflation? No. Two arguments are generally given in order to link a high fiscal deficit to inflation. The first argument is based on the fact that the part of the fiscal deficit which is financed by borrowing from the RBI leads to an increase in the money stock. Some people hold the unsubstantiated belief that a higher money stock automatically leads to inflation since "more money chases the same goods". There are, however, two flaws in this argument. Firstly, it is not the "same goods" which the new money stock chases since output of goods may increase because of the increased fiscal deficit. In an economy with unutilized resources, output is held in check by the lack of demand and a high fiscal deficit may be accompanied by greater demand and greater output. Secondly, the speed with which money "chases" goods is not constant and varies as a result of changes in other economic variables. Hence even if a part of the fiscal deficit translates into a larger money stock, it need not lead to inflation. The second argument linking fiscal deficits and inflation is that in an economy in which the output of some essential commodities cannot be increased, the increase in demand caused by a larger fiscal deficit will raise prices. There are several problems with this argument as well. Firstly, this argument is evidently irrelevant for the Indian economy in 2002 which is in the midst of an industrial recession and which has abundant supplies of foodgrains and foreign exchange. Secondly, even if some particular commodities are in short supply, rationing and similar strategies can check a price increase. Finally, if the economy is in a state which the proponents of this argument believe it to be in, that is, with output constrained by supply rather than demand, then not just fiscal deficits but any way of increasing demand (such as private investment) is inflationary. Doesn't a Greater Fiscal Deficit Lead to a Greater Drain on the Exchequer in terms of Interest Outlay? Yes and no. Certainly, for a given interest rate a larger fiscal deficit by raising the accumulated debt of the government raises the interest burden. However, in the particular case of our economy since liberalization, a large part of the increasing interest burden is because of the rise in the interest rates in the post '91 period. This itself is related to the process of liberalization since the rate of interest has to be kept high in a liberalized economy to prevent capital outflow. Moreover, a growing domestic debt is not a problem for a government in the same way in which growing debt is a problem for a family since the government can always raise its receipts through taxation and by printing money. Some would say that printing money would lead to inflation, but as we have shown above, this is not necessarily the case. Is it a Good Idea to Reduce Fiscal Deficits Through Disinvestment? No. The PSUs that the government has been disinvesting in are the profit making ones. Thus, while the government earns a lump-sum amount in one year, it loses the profits that the PSU would have contributed to the exchequer in the future. Therefore, it is not a good idea even if the objective is to reduce the fiscal deficit. Does increased government expenditure necessarily lead to a greater fiscal

    http://www.macroscan.org/eco/aug02/print/prnt170802Fiscal_Deficit.htm

    7/27/2013

    MacroScan (Printable Version) - Fiscal Deficit


    deficit? Not necessarily. Suppose the government spends more on an electricity project for which the contract is given to a PSU like BHEL. Then the money that the government spends comes back to it in the form of BHEL's earnings. Similarly, suppose that the government spends on food-for-work programmes. Then a significant part of the expenditure allocation would consist of foodgrain from the Public Distribution System which would account for part of the wages of workers employed in such schemes. This in turn means that the losses of the Food Corporation of India (which also includes the cost of holding stocks) would go down and hence the money would find its way back to the government. In both cases, the increased expenditure has further multiplier effects because of the subsequent spending of those whose incomes go up because of the initial expenditure. The overall rise in economic activity in turn means that the governments tax revenues also increase. Therefore there is no increase in the fiscal deficit in such cases. What is the Impact of the Government's Policy of Decreasing the Fiscal Deficit? Logically, there are two ways in which the fiscal deficit can be reduced by raising revenues or by reducing expenditure. However given the character of our State and the constraints of a liberalized economy, the government has not increased revenues. In fact, in budget after budget the government has actually given away tax cuts to the rich. Even when it has tried to raise revenues, it has been through counterproductive means like disinvestment. The main impact of the policy of reduced fiscal deficits has therefore been on the government's expenditure. This has had a number of effects. First, government investment in sectors such as agriculture has been cut. Secondly, expenditure on social sectors like education, health and poverty alleviation has been reduced leading to greater hardship for the poor already bearing the brunt of liberalization. Perhaps most importantly, in an economy going through a recession the government is not allowed to play any role in boosting demand.

    Page 2 of 2

    MACROSCAN 2002

    http://www.macroscan.org/eco/aug02/print/prnt170802Fiscal_Deficit.htm

    7/27/2013

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