(a) When the government makes arrangement for a separate fund for meeting the debt obligations, it is called funded debt. The funded debt is also called long-term public debt. On the other hand, while taking loan if the government does not create any separate fund for the repayment of the principal sum along with interest, it is called unfunded debt or floating debt. The unfunded debts are short term debts.
Three purposes of Public debt:
1. Covering the gap between the expenditure and tax revenue: If the government’s revenue from taxes and other sources’ falls short of expenditure, public borrowings become a necessity. The excess of government’s expenditure: over its revenue creates a deficit in the government budget. The growing deficit in the government budget has been the principal reason for public borrowings in India.
2. Controlling Inflation: Public debt is used, side by side with taxes, as an instrument of Inflation control. At times of inflation, government tries to reduce the purchasing power of consumers, so that the pressure of excess demand may be reduced. Like taxes, public debt also takes money away from people’s hand.
3. Development Financing: In a developing economy like India, the government often has to play a leading role in economic development. For raising the necessary funds, the government takes recourse to borrowing from the public. In India, public debt has been a major source of financing the development finance.
(b) Inflation: Inflation is a rise in price levels with additional characteristics. It is incompletely anticipated, it does not increase to further rises, it does not increase employment and real output.
Four factors that cause demand-pull Inflation:
1. Increase in Population: Increase in population refers to increased demand of consumer goods, which puts a pressure on existing supply of goods and services thus resulting in inflation.
2. High Rate of Investment: The heavy investment made by the Government as well as private industrialists have resulted in continuous increase in the prices of capital goods and other items of production.
3. Black Money: It is created through tax evasion and is responsible for price rise. It is spent on non-productive activities like buying real estate in urban areas, gold smuggling, luxurious items etc.
4. Deficit Financing: Deficit financing increases the money supply in public hands, therefore increasing the demand of goods and services.