Deficit Financing

The financing of the deficit corresponds to obtaining resources to be able to solve a situation where government revenues are lower than their expenses.

Deficit financing is the way in which the government decides to solve the negative difference between its income and expenses. There are several alternative paths, however, none of them are without problems.

Alternatives for deficit financing

There are several financing alternatives, all of them have disadvantages that it is necessary to keep in mind when making a decision:

Issue money

An apparently simple way to finance the difference between income and expenses is to issue more money . In some countries, this decision is the exclusive power of the government, which can decide how much money to issue.

The main disadvantage of this alternative is to create inflation . Creating more money (without any real support) leads to the value of money being reduced. The above implies that goods and services will tend to increase their price and with this inflation will be generated.

To raise the taxes

Another option is to increase one of the government’s most important sources of resources: tax collection . However, the tax increase can have negative consequences on the economy. Since families see their disposable income reduced, they will buy less goods and services. Companies will sell less. Its production and the number of employees will then be reduced.

In the end, raising taxes (over a certain limit) can cause production to fall, generate unemployment and even reduce revenue.

Generate public debt

Another way that the government can take is to borrow from companies, families and other agents in the country. One way to do this is through the issuance of government bonds that offer an interest rate and / or other attractive conditions for potential buyers.

This alternative would tend to reduce the negative effect of inflation by emission, however, it is also not free from problems. Among them we find that, since the government must attract buyers with an attractive interest rate, in the future it will be forced to pay interest . In this way, it is possible that the debt is only being transferred from today to tomorrow.

Monetization of debt

Another drawback is that, as resources are limited, when the government manages to obtain resources from private or private banks, these resources are being used for the investment of private companies or family projects, which in the Future may have an impact on lower growth.

Additional considerations

The issue of the deficit is usually addressed from the point of financing them. That is, how can we finance the money we need? However, if the deficit is maintained in the long term, companies, governments or other institutions run the risk that their debt reaches unsustainable levels.

Thus, given the harmful effects of the issuance of money for financing the deficit in the economy, many countries have decided to ban it or only allow it under very restricted circumstances.

A usual formula for controlling emission by the government has been the creation of independent central banks, which are managed by technical (non-political) personnel.

And why not eliminate or reduce the deficit?

Although it is not a form of financing, since if it does not exist it cannot be financed, eliminating or reducing the deficit is a way of avoiding the damaging effects of it. Now, how to reduce the deficit?

There are two ways to reduce the deficit:

  • Enter more: That is, generating value. For example, encouraging research on products that can then be exported to the rest of the world. We could also add the fight against corruption (embezzlement) or the fight against tax evasion.
  • Spend less: Make cuts in services or public goods. Although it is usually an unpopular measure, it is a way to reduce it. At this point, it should be noted that spending less does not have to imply social cuts. Since if the expense is more efficient, you can even get more services with a lower cost.

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