Social Scientist. v 14, no. 156 (May 1986) p. 33.

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Limit to Non-Inflationary Deficit Spending

IN THE PLANNING process government expenditure has increased several-fold over the pre-plan level. This expansion in government expenditure has been financed mostly by mobilising resources through tax and non tax sources, market borrowings and deficit financing defined in terms of money creation. These different sources of financing expenditure can be expected to have a differential impact on sectoral output and on the price level. Financing through taxation involves withdrawal of purchasing power from the household sector and of investable resources from the corporate sector. The inflationary impact, through the demand side, of this mode of finance depends on the net additional demand generated in different sectors by the combined influence of a withdrawal of funds and of government expenditure on the one hand and the availability of excess capacities in the affected sectors, on the other. Besides, taxation may also lead to cost push inflation through forward shifting of taxes. Similarly, mobilisation of funds through internal market borrowing may also lead to a crowding out of private funds owing to a liquidity crunch. The effect of this mode of finance on sectoral output and inflation is difficult to determine. Ideally, while examining the inflationary impact of increased government expenditure, the total effect of various modes of financing the expenditure should be considered along with the demand implication of the expenditure programmes. In this paper, however, we have taken up the limited issue of price effects of one of the modes of financing additional governemnt expenditure, namely deficit financing. We examine this issue with reference to the Union Government expenditure for 1971-72 in the inter-industry consistency framework.

It is widely held that deficit financing as a source of financing government expenditure invariably leads to inflation through generation of excess demand. In conu < to this widely held view, we have argued that an increase in government expenditure financed through deficit financing need not necessarily lead to inflation in an economy like India's where several manufacturing sectors are known to be characterised by excess capacity and that it can happen only if there is non-compatability between the composi-

* Professor at the Indian Statistical Institute, New Delhi.

*;:; Indian Statasrical Institute, New Delhi

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