Schools of thought on deficit financing through debt

The budget deficit is also still one of the main issues of concern for many economists and policy makers especially budget deficit is a key criterion in rating the economic strength of countries of the world.


Lo’ai Batainah – –

All GCC budgets are witnessing growing deficits that are not expected to be controlled on the short-run due to their inability to compensate the sharp decline in oil revenues from the sharp fall in oil prices.
These countries started financing such deficit through direct and indirect borrowing from the local and foreign financial markets with many currencies including the US dollar, which is the official currency for world oil trade.
There are many economic schools for addressing such situation, the most known of which are the Keynesian school and the classic school.
The main difference between the two schools is how governments manage their own financial budgets and have financial deficit.
Keynes advocated making a financial deficit to be financed through debt to set up various projects.
This is contrary to the classical economists who believe that the expenditure should be equivalent to revenues.
The financial deficit, as defined by economists, is the borrowing by the government represented by the central bank and other commercial banks to cover the deficit at the state budget.
This way has many negative effects on the economy, the most notable of which is the inflation and price hike due to money circulation.
Unfortunately, many developing countries suffer from this ballooning deficit and inability to control inflation due to sharp increase in money supply coupled with lack of supplies.
This situation is the direct outcome of the financing deficit.
The financial deficit at the state budget of any given country is one of the hot debates among the different economic schools, starting from the classical until the Keynesians.
The budget deficit is also still one of the main issues of concern for many economists and policy makers especially budget deficit is a key criterion in rating the economic strength of countries of the world.
The classical school of economics advocates the neutrality of state and noninterference in economic activity; neutrality of fiscal policy, a balanced state budget and not to achieve deficit at all. This advocacy is justified by a number of reasons including but not limited borrowing by the government do not add energy to the production.
It will rather lead to withdrawal from the sources available for private sector and allocating them to government consumption.
It is also because government borrowing weaken the state’s ability to finance the state budget in the future.
The burdens of debt service are thus transferred and the principal loan is repaid at the coming year.
They also believe that unbalanced state budget lead to a growth in public expenditure and consequently taking measure that push forward for more tax collection.
The fiscal deficit will lead to depreciation of currency and price hike.
The latter problem requires more money to solve therefore the value of the currency will deprecate and the price will soar more and more.
This leads to continuous deficit which in turn will make the economy runs in a vision circle of inflation and deficit.
Keynesians believe that the government should interfere to ensure full utilization and balance of the public revenues by introducing fiscal and monetary policies and creating state budget imbalance to restore this balance.
Keynes advocates noncompliance with the balanced budget and that budget deficit is desirable as long as it will lead to more employment opportunities.
He believes that unemployment.
Low production issues could be addressed and economic balance may be created by financing through debt (budget deficit). In such scenario, the public expenditure will be increase to the level when stability is achieved and when the economy is facing inflation.
This may be controlled by achieving surplus in public revenues by increasing taxes and reducing public expenditure.
Advocates of financing through debt or inflationary financing believe that this will help in activating mandatory saving by increasing prices and reducing consumption.
This will result in having more resources for investment.
The mandatory saving realized from financing through debt can be divided into two categories.
The first one is the in-kind saving which results from the price hike due to increase in the payment methods.
The low-income category people are unable to consume part of the production due to price hike.
This means that part of the GDP is not consumed and therefore can be utilized by the government in investment.
To achieve this, the financing by deficit should not be associated with wage increment or monetary saving.
This is achieved by the businessmen and high-income people.
The price hike and reduced purchase power will lead to redistribution of income to their favour; as they have high ability to save.
They will thus increase their monetary saving due to price hike and channel such saving towards investment.
This will lead to more employment opportunities and enhance the growth of economy. In other words, financing through debt will lead to increase in the capital formation.
This will lead us to the conclusion that Keynesian school believes in the efficiency of the state budget and rejects the neutrality of fiscal policy.
They also believe that imbalanced state budget may be necessary to achieve balanced economy in general.
Some economics believe that financing through deficit is an efficient tool in terms of allocating financial resources, as the economic resources will be diverted from the private sector to the public sector.
In such scenario, the state can control the new monetary issues and its ability to borrow from the banking system.
The financing through deficit thus gives that government a purchasing power that help it control economic resources.
Financing through deficit will also lead to better utilization of economic resources by increasing demand.
This is because increased public expenditure and raising per capita income leads to increased demand on consumption goods.
The price hike resulting from increase of money supply make businessmen more optimistic and thus encouraging them to invest more and more, which in turn will ensure better utilization of the economic resources.
(Many studies, reports, publications and economic reference have been used in brief.)