Deficit Financing and Economic Development

After reading this article you will learn about deficit financing as a tool of economic development.

Deficit financing is an extraordinary fiscal device of development finance in modern times. In developed countries J.M. Keynes, popularized this concept, with a view to fight and control depression which is often accompanied by unemployment.


Prof. J.M. Keynes, through the instrument of pump priming, advocate deficit financing to finance public works projects in developed countries during the nine­teen thirties depression period.

Increased public expenditure, fi­nanced through deficit financing was considered as an effective fis­cal tool to mitigate the evils of unemployment and deficiency in pri­vate spending and investment in developed economies is made pos­sible through the effect of multiplier on employment and income.

However in developing countries deficit financing is generally resorted to achieve rapid economic development. It is considered as the easiest method for extracting savings by force in the domestic economy at present it occupies an important place in the financing of the economic activities in developing economies.

If the technique is used prudently with safeguard it is a proper drug for curing the economic problems and to promote economic development. But if it is used carelessly it is like a nuclear bomb, harmfully to the whole economy.

There are several reasons behind advocating deficit financ­ing as a tool of economic development in developing economies.

Firstly in developing economies, voluntary savings are low on ac­count of mass poverty and higher marginal propensity to consume As a result the taxation base and tax yield are very low leading to inadequate revenue mobilization. Political pressure also acts as a factor influencing the level of tax tolerance in the economy.


In such a situations the government can raise the required revenue for fi­nancing increased public expenditure by way of deficit financing. Secondly in developing economies generally, there exist large quantity of unutilized physical and man power resources.

Lack of sufficient capital is the prime factor hindering resources utilization therefore deficit financing can be utilized to mobilize the dormant resources in these economies. Thirdly during the process of eco­nomic development, the national income of developing economies may register consistent increase an account of planned develop­ment.

As such money supply should increase correspondingly, to activate idle resources and to divert productive resources from un­productive channels to productive channels. Fourthly in a developing economy, as large part of the economy in rural area remain non- monetized.

As the development process gathers momentum the size and volume of non-monetized sector shrinks, which necessi­tate increased monetary demand. Thus additional money supply created under deficit financing, speeds up the process of monetization of rural sector and provides the right impulses for economic motivation.


Fifthly resources mobilized by way of deficit financing can be utilized properly by the government towards canalizing ad­ditional resources for the creation and the development of social and economic overheads, which are basic requirements for rapid eco­nomic development.

Deficit financing is a useful technique if it is handled properly with sufficient care, Deficit financing can be justified to the extent that it helps to stimulate rapid economic development.

However deficit spending without any limit is dangerous to the economy as a whole. It may generate inflationary situations and even shake the confidence of the people in the stability of the economy. Through deficit financing government is able to raise adequate resources without paying interest. It helps the government to transfer resources rela­tively with less opposition.

Deficit financing does not always lead to inflation. If the resources mobilized through deficit financing is used to activize economic de­velopment it will not contribute towards inflationary situation. Suc­cessful use of the tool of deficit financing is conditioned by a number of factors like maturity of the political system, structure of the economy, resources potential, efficiency of the monetary manage­ment system etc.


Factors like market imperfection structural rigidi­ties, inelastic supply of working capital etc., act as inhibiting factors in the process of the economic development. In an economy characterized by these factors, the use of deficit financing for eco­nomic development may generate inflationary pressure.

Therefore deficit financing is not an unmixed blessing of course a mild doze of deficit financing is really a tonic to economic development. The efficiency of the fiscal system is a crucial factor in determining the impact of deficit financing on economic development of developing countries.

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