From UPSC perspective, the following things are important :
Prelims level: Not much
Mains level: Paper 3- Debt financing versus money financing
The article addresses the issue of apprehensions over money financing. It also compares the option of borrowing from international institutions.
Issues with public spending
- Greater public spending will increase the fiscal deficit and this expansion has to be financed.
- Theoretically, it can be financed by higher taxes.
- But when the economy is in a recession, this option cannot be explored even though the balanced-budget multiplier is one.
- When the multiplier is one, output expands by exactly the same amount as the increase in government spending.
So, what are the options?
There are two options
1) Issuing debt to the public (Debt financing)
2) Borrowing from the RBI (Money financing)
Borrowing from World Bank and IMF?
This borrowing has 4 issues with it-
- 1) This borrowing will have to be paid back in hard currency.
- This would involve India having to earn hard currency by stepping up exports.
- If a stimulus of approximately 10% of the GDP is envisaged, with exports at 25% of the GDP, it would imply stepping up exports by close to 50%.
- This would be a herculean task under present circumstances.
- 2) There is the issue of conditionalities.
- It is not obvious what conditionalities will come along with the loan.
- 3) The loan is bound to take some time to be negotiated, taxing the energies of a government that ought to be engaged in the day to day battle with COVID-19.
- 4) The external debt is truly national which, arguably, government bonds held by the country’s private sector are not.
Issues with money financing
- The standard economic argument against money financing is that it is inflationary.
- However, whether a fiscal expansion is inflationary or not is related more to the state of the economy than the medium of its financing.
- When resources are unemployed, output may be expected to expand without inflation.
Consider the question “Examine the issues with the money financing of the fiscal deficit.”
Conclusion
There is no reasoned case for denying ourselves the option of money financing to take us back to pre-COVID-19 levels of output and employment.
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