Deficit financing is that, which, if used responsibly, can lead an economy to prosperity; however, if used thoughtlessly, can do the opposite. It is the tool suggested years ago by known economist John Keynes, and used today throughout the world by various finance ministers of different economies in their budgets.
Let us begin our understanding of this important tool by knowing its meaning. It is a practice by which a government spends more money than it receives as revenue, the difference being made up by borrowing or minting new funds (the printing of new currency notes and making of coins). As highlighted earlier, the influence of such practice upon national economy may be very great. It is perhaps for this reason that a deficit budget is usually the result of a conscious attempt on part of the Finance Minister.
Having got the meaning of the word, let us go through the consequences of deficit financing.
Generally, deficit financing is used as a tool to stimulate the economy of a nation. It involves the establishment of a specific plan of action which is supposed to launch a chain of events that ultimately enhances the financial condition of the economy. For example, when borrowed resources are used in establishment of factories, such factories will cater to the demands of people, and also generate employment. This will restore consumer confidence and bring the economy on the growth track. This is also the reason why deficit financing was suggested by marked economists like John Keynes.
But, when the deficit crosses a limit, it becomes a menace due to large borrowings and its ill effects. The same will be explained in the following points. Note that each point has a relation to the previous point.
Inflation: As the borrowings increase, the money supply in the economy increases, consequently the purchasing power of people increases. The same leads to a surge in the aggregate demand and it results in a price increase, thus, inflation.
Adverse effect on saving: As the prices of various commodities rise, it no longer remains possible to maintain the previous rate of savings.
Adverse effect on investment: Higher inflation and lower rate of savings leads the workers to demanding higher wages, resulting in decreased efficiency, uncertainty in business and consequently lower investment.
Inequality: As the prices increase, the distribution of income becomes more and more unequal. The rich become richer and the poor poorer.
Problem of Balance of Payments: Inflation makes exports expensive and imports attractive. As a result, the Balance of Payments becomes unfavourable.
Increase in the cost of production: Again a result of inflation.
Change in the pattern of investment: A turbulent economy encourages speculative activity which not good for the economy’s health due to spoiled investment pattern.
From the above, it can be inferred that the main consequence of irrational deficit financing is inflation while the other effects follow inflation.
In India, deficit has been high to alarming rates and is on a continuous rise. Due to the same, the future of the economy seems dark and the indecisiveness of the current government regarding the same is expected to be overcome by a new government at the Centre in a few months, which will perhaps improve the scenario.