How can a deficit budget be financed

 A budget deficit occurs when government expenditure (G) is greater than revenue (T) (G>T). There are several main ways that the Bangladesh government can finance a deficit.

i.      Firstly, the government can borrow funds from the other sectors of the economy. This involves the selling of new Commonwealth Government Securities (CGS) such as treasury bonds through a tender system.

 

This is the preferred government method of raising funds, as it does not add to net foreign debt, because the government is not borrowing from overseas. However, there is a disadvantage to this form of debt financing.

 

When the Federal Government sells CGS it competes with the private sector for domestic savings, creating what is referred to as a “crowding out effect”. A shortage of funds in the domestic market can result and domestic investors may need to borrow funds from overseas. Government borrowing has then, effectively “crowded out” private investment. Private investment may be postponed as interest rates and the cost of credit rise.

 

ii.      The second possible method of financing a deficit is for the Commonwealth Government to sell CGS to the Reserve Bank. This form of borrowing from the Reserve Bank basically means that the government prints money to finance the deficit. The Government has not used this method of deficit financing since the deregulation of the Australian financial market in

1982. This is because it is highly inflationary: when the government spends the money, there is an increase in the money supply; if the economy is near full employment, demand inflation occurs rapidly, as there is too much money chasing a limited supply of goods.

 

 iii.       The third possible method used to finance a budget deficit is for the government to borrow funds from international financial markets. The government has not borrowed from overseas since the late 1980s to finance the deficit. When using this method, the Reserve Bank sells new CGS to overseas buyers, and receives foreign funds that are converted into Australian dollars. This method of financing the deficit adds to foreign debt when interest is paid on the securities (net income component of the balance of payments).

 The government may decide to borrow funds from overseas to reduce the crowding out effect. Under a floating exchange rate such borrowing has no effect on the domestic money supply. However, exchange rates and domestic interest rates can be affected; further, it adds directly to foreign debt.

iv.       The selling of government assets is an alternative method to borrowing that the government can also use to fund a budget deficit. The sale of assets can create a headline budget surplus and reduce the crowding out effect typically caused by the sale of government bonds.

 

What is meant by budget deficit

 A financial situation that occurs when an entity has more money going out than coming in. The term "budget deficit" is most commonly used to refer to government spending rather than business or individual spending. When it refers to federal government spending, a budget deficit is also known as the "national debt." The opposite of a budget deficit is a budget surplus, and when inflows are equal to outflows, the budget is said to be balanced.

Government budget deficits can be cured by cutting spending, raising taxes or a combination of the two. Deficits must be financed by borrowing money. Interest must be paid on borrowed funds, which worsens the deficit

Discuss the problems faced in estimating the GDP of a country

 First, GDP figures omit production of goods and services that are not sold on markets. This component includes housework, meals cooked at home, and child care provided by parents, as well as services volunteered for charities and other groups. For example, when parents care for their own children, the value of their care does not appear in GDP. However, when parents pay for child care, those services appear in GDP (for more examples see the book).

 

Second, GDP includes only a very imperfect estimate of production of goods and services sold on the underground economy (or black market). This activity includes production of illegal goods and services (such as drugs and prostitution). It also includes production of legal goods that goes unreported to avoid taxes. Many estimates suggest that the underground economy in the United States amounts to between 5 and 10 percent of GDP; this figure is even larger in many other countries.

 

Third, special measurement problems result when GDP includes certain goods that are not sold on markets. When you rent a house or apartment, your expenses appear in GDP as payments for housing services. However, if you own the house or apartment where you live, GDP includes the government’s estimate of the rent that you would pay if you were renting.

 

Fourth: Substitution bias: As consumers' tastes change and as new technological improvements are introduced, the relative prices of goods change. Such changes are independent of inflation so optimally we would like the real GDP measure to take them into consideration. For example, as more people started using cellular phones, the cost of supplying this service went down and so has price. In the real GDP the value of these services is measured using old, higher prices, overstating the increase in the value of production.

 

New-good bias: it is very difficult to include new goods into the real GDP: In the base year they did not exist and hence their price was infinite.

 

Quality-change bias: if you simply take the number of TV sets produced and multiply it by the price of a typical TV set in the base year, the value of production is going to be underestimated, as this measure does not take into account the improvements in quality.