LIVE Course for free

Rated by 1 million+ students
Get app now
0 votes
in GK by (30.0k points)
closed by
What is the effect of deficit financing on economy?
1. Reduction in taxes
2. Increase in wages
3. Increase in the money supply
4. Decrease in money supply

1 Answer

0 votes
by (54.3k points)
selected by
Best answer
Correct Answer - Option 3 : Increase in the money supply

The correct answer is Increase in the money supply.

  • Effects of Deficit financing on the economy:
    • Deficit financing can have a useful role during the phase of depression in a developed economy.
    • During this phase, the level of expenditure falls down to a very low level and the banks and the general public are in no mood to undertake the risk of investment.
    • They prefer to accumulate idle cash balances instead, which leads to an increase in the money supply.
    • The machinery and the capital equipment are all present there but the incentive to produce is lacking due to a deficiency in aggregate demand.
    • It is in this scenario that the government pumps in additional purchasing power in the economy through deficit financing the level of effective demand is likely to increase.

  • Deficit financing:
    • Deficit financing means generating funds to finance the deficit which results from an excess of expenditure over revenue.
    • The gap is covered by borrowing from the public by the sale of bonds or by printing new money.
    • For developing countries like India, higher economic growth is a priority.
    • A higher economic growth requires finances.
    • With the private sector being shy of making a huge expenditure, the responsibility of drawing financial resources rests on the government.
    • Often both the tax and non-tax revenues fail to mobilize enough resources just through taxes.
    • The deficit is often funded through borrowings or printing new currency notes.
    • Deficit financing affects investment adversely.
    • When there is inflation in the economy employees demand higher wages to survive.
    • If their demands are accepted it increases the cost of production which de-motivates the investors.

Welcome to Sarthaks eConnect: A unique platform where students can interact with teachers/experts/students to get solutions to their queries. Students (upto class 10+2) preparing for All Government Exams, CBSE Board Exam, ICSE Board Exam, State Board Exam, JEE (Mains+Advance) and NEET can ask questions from any subject and get quick answers by subject teachers/ experts/mentors/students.