Definition

Deficit financing occurs when a government funds expenditures, such as new government programs or government construction projects, by using debt instead of income. Governments receive a large amount of income through taxes, but they also get funds by selling debt instruments like bonds. Typically, government bonds are very popular in the debt market if the government is stable, and it is easy for the government to raise money in this manner.

Benefits

When used correctly, deficit financing increases the amount of spending in the debt market and has a favorable effect on economic conditions, making people more willing to spend money on a variety of businesses. In the end, this activity will raise greater amounts of income, from which the government draws greater amounts of taxes to cover the deficit. In the meantime, the government can use the funds it receives to immediately pay pressing expenses.

Considerations

If used incorrectly, deficit spending can put governments in a dangerous and unstable position. Eventually, the bonds the government uses will come due and the government must be prepared to pay them off when this occurs. Also, increasing the number of government bonds in the market can increase competition over bonds, which raises interest rates. Interest rates across the economy will tend to follow suit, making it difficult for many people to afford loans.

Micro Purposes

References

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