The acquisition of funds through the financial markets by the government sector which are used to finance government expenditures. In terms of the simple circular flow model, this is one of two basic demands for household saving diverted into financial markets. The other is investment borrowing. Government borrowing is also one of two methods of financing government expenditures. The other is taxes.
Government
borrowing by the government sector can be illustrated with the circular flowmodel. The circular
flow captures the continuous movement of
production, consumption,
income, and factor payments
between producers and consumers.
The household sector at the far left contains the consuming population of the economy. The business sector at the far right includes all of the producers. The government sector is positioned in the middle of the diagram and the foreign sector is at the very top.
The product markets near the top of the flow direct production from the business
sector to the household sector in exchange for payment flowing in the opposite
direction. The resource markets at the bottom of the flow direct factor services from the household sector to the business sector in exchange for payment flowing in the opposite direction. The financial markets located just above the resource markets divert saving from the household sector to business and government borrowing.
• If the economy has only a small supply of savings, increased government borrowing may force up interest rates and crowd out private sector investment
• If the national debt increases,
annual
interest
payments
on the debt goes up - money that might have been spent in priority areas