How to finance a budget deficit (1 Viewer)

[baraka003]

what is the best/most appropriate method of financing australia's current budget deficit?

 

[Zak Ambrose]

PRINT MORE MONEY.


i dont know how the current deficit is being financed. but i would assume selling bonds to the domestic private sector. seems too shaky to borrow from overseas atm and too inflationary to borrow from the RBA.

 

[FFC]

There are three major ways in which a budget deficit (total government expenditures exceed total government receipts): borrowing from the public, borrow from the Reserve Bank of Australia (the RBA) or borrow from overseas.

The first involves the selling of government bonds/securities to households and firms, whereby the government offers a rate of interest in return for people's surplus funds. This does not create inflationary tendencies (as the money supply is held constant) and avoids foreign instability that may arise from accumulating foreign debt. However, by adding another investment/savings option into the market, the government provides additional competition in the market, which can force interest rates up. This effect is known as "crowding out". In weaker economic conditions, such as those experienced currently, this crowding out can be amplified, as the private sector is driven out by the government, further slowing already weak private investment and consumption.

The second method is borrowing from the Reserve Bank, so as to increase the money supply in the economy and help finance the shortfall in government revenue. In doing so, this can lead to upward demand-pull inflationary pressures in the economy, if the increase in money supply does not lead to an increase in GDP. If Australia's inflation outlook were weaker than it is currently then this method might be the most appropriate. However given the fact underlying inflation is still 3.9% and unemployment is expected to rise further in coming months, this method may lead to high inflation and slow EG (stagflation) in the local economy if global conditions weaken.

The third method is to borrow from overseas, by way of foreign debt. Foreign debt avoids the internal economic problems discussed above (crowding out and inflation), and can be beneficial in terms of supporting domestic savings to help expand the productive capacity of the economy. However there are costs, by way of rising income remittances (feeding the current account deficits of the future) and the burden and constraints on future governments (and thus taxpayers).

However given Australia's good starting position - negative net public sector debt (i.e. status of "creditor"), responsible borrowing from overseas appears to be the most appropriate method of financing the budget deficit. So long as the debt levels do not rise unsustainably, then the government can avoid the costs of the other two methods (borrowing from the public and the RBA) and sustainably finance the budget deficit of the current downturn, before eventually returning the budget to surplus.

 

[Zak Ambrose]

does anyone know with method is actually being used to finance this deficit? i've looked but am yet to find.

 

[gnrlies]

There are three major ways in which a budget deficit (total government expenditures exceed total government receipts): borrowing from the public, borrow from the Reserve Bank of Australia (the RBA) or borrow from overseas.

The first involves the selling of government bonds/securities to households and firms, whereby the government offers a rate of interest in return for people's surplus funds. This does not create inflationary tendencies (as the money supply is held constant) and avoids foreign instability that may arise from accumulating foreign debt. However, by adding another investment/savings option into the market, the government provides additional competition in the market, which can force interest rates up. This effect is known as "crowding out". In weaker economic conditions, such as those experienced currently, this crowding out can be amplified, as the private sector is driven out by the government, further slowing already weak private investment and consumption.

The second method is borrowing from the Reserve Bank, so as to increase the money supply in the economy and help finance the shortfall in government revenue. In doing so, this can lead to upward demand-pull inflationary pressures in the economy, if the increase in money supply does not lead to an increase in GDP. If Australia's inflation outlook were weaker than it is currently then this method might be the most appropriate. However given the fact underlying inflation is still 3.9% and unemployment is expected to rise further in coming months, this method may lead to high inflation and slow EG (stagflation) in the local economy if global conditions weaken.

The third method is to borrow from overseas, by way of foreign debt. Foreign debt avoids the internal economic problems discussed above (crowding out and inflation), and can be beneficial in terms of supporting domestic savings to help expand the productive capacity of the economy. However there are costs, by way of rising income remittances (feeding the current account deficits of the future) and the burden and constraints on future governments (and thus taxpayers).

However given Australia's good starting position - negative net public sector debt (i.e. status of "creditor"), responsible borrowing from overseas appears to be the most appropriate method of financing the budget deficit. So long as the debt levels do not rise unsustainably, then the government can avoid the costs of the other two methods (borrowing from the public and the RBA) and sustainably finance the budget deficit of the current downturn, before eventually returning the budget to surplus.

Quite an impressive answer, well done.

The only thing I would add is that the inflation caused by 'printing money' is due to an increase in the money supply itself, and not demand. As such economists usually refer to this as monetary inflation as opposed to demand pull inflation (as the inflation does not arise from any kind of demand shock).

 

[gnrlies]

does anyone know with method is actually being used to finance this deficit? i've looked but am yet to find.

In response to your question, the government has done what it always does when financing a deficit. It has issued government securities. Now these are available to both foreign and domestic borrowers, so although they are sold on Australian markets, the funds come from both domestic and foreign sources.

Of the three mentioned above, this is the only one used in Australia. Seigniorage (printing money) is usually assosciated with countries who have a credibility problem and are unable to source finance, and borrowing abroad is usually regarded as more expensive and occurs where a country has a significant default risk and is unable to inexpensively acquire funds domestically. The other classic example of this involves countries obtaining funds from international organisations such as the World Bank and the IMF although it could also come from private means as well.

 

[FFC]

Quite an impressive answer, well done.

.

Thankyou Got 5/5 for that question on my test last week, so happy with that!!

The only thing I would add is that the inflation caused by 'printing money' is due to an increase in the money supply itself, and not demand. As such economists usually refer to this as monetary inflation as opposed to demand pull inflation (as the inflation does not arise from any kind of demand shock).

Hmmm, point noted. But aren't they linked? When you increase the money supply relative to the level of output in the economy, you are creating the potential for demand that simply cannot be matched. The demand in this case would be on behalf of the government, but demand nonetheless. The inflationary pressure only comes about because the extra money in the money supply is used to purchase G&S, invest etc etc. If it was simply saved or held, it should not impact general price levels? Wouldn't this "printing money" business therefore lead to a demand shock, and thus DP Inflation?

Not too sure

 

[gnrlies]

Thankyou Got 5/5 for that question on my test last week, so happy with that!!



Hmmm, point noted. But aren't they linked? When you increase the money supply relative to the level of output in the economy, you are creating the potential for demand that simply cannot be matched. The demand in this case would be on behalf of the government, but demand nonetheless. The inflationary pressure only comes about because the extra money in the money supply is used to purchase G&S, invest etc etc. If it was simply saved or held, it should not impact general price levels? Wouldn't this "printing money" business therefore lead to a demand shock, and thus DP Inflation?

Not too sure

Sure, I take your point and your logic is not flawed, however there is a difference between demand pull inflation and monetary inflation in the way the process works.

Economics regard money as a numeraire used to compare the relative value of goods. It is a unit of exchange that has no intrinsic value of its own, instead deriving its value from its ability to exchange for goods and services. Price is essentially a relative term, and it is easier to deal with price in terms of money as it allows us to compare all goods.

With this in mind, economists have a term known as 'money illusion' which deals with the way in which people view money. Conversely, economists have a concept known as 'no money illusion' which is perhaps an easier place to start. 'No money illusion' essentially means that if you double a persons income, and you double the price of all goods and services, then the individual will demand exactly the same as they would before. The reason is because there has been no change in the real economy. Relative prices have not changed. In this respect we regard a doubling of the money supply as producing monetary inflation and not demand inflation because there has been no change in demand. People demand the same amount of goods and services, and as such it is impossible to say that inflation has risen due to an increase in demand. Now I don't want to get into the technicalities of the walrasian auctioneer, but people make demand responses based on relative prices and incomes, and not absolute prices and incomes. If I was to discuss the walrasian auctioneer, you would see why an increase in money does not actually increase demand (because the walrasian auctioneer assumes that all trade takes place at the same time incorporating the implications of a doubled money supply).

Demand inflation only results when there is an actual change in the quantities demanded by households. In other words in one period a person may demand 5 widgets and in another period they may demand 10. This produces demand pull inflation because it changes relative prices (whereas monetary inflation does not change relative prices). It might be possible that with 'money illusion' a person whose income doubles (with prices also doubling) might perceive their income to be higher and as such increase their demand for a particular good. This would essentially result in a change in demand and as such could lead to inflation as you suggested. You might imagine that this essentially just means that one good becomes more expensive and others become cheaper. With that assessment you would be correct. If we regard inflation as meaning that all prices rise, it is hard to regard demand pull inflation as a real source of inflation. This is why the monetarism movement essentially said that the only kind of inflation is monetary inflation.