Deficit Financing: Definition & Concept

Instructor: Brianna Whiting

Brianna has a masters of education in educational leadership, a DBA business management, and a BS in animal science.

In this lesson, we will learn about deficit financing. We will define the term and learn some facts that surround this practice. The lesson will conclude with a summary and a quiz.

A First Look at Deficit Financing

Let's take a minute to look at the business practices of Kate. Kate owns Joyful Jewelry and specializes in selling children's jewelry. When Kate first opened her business, she had tremendous sales and extremely loyal customers that always came to her first when looking for that special gift for the little girls in their lives.

However, due to a poor economy, Kate's business began to feel the effects in terms of lost sales. Not sure how to bounce back, Kate began doing research on other businesses that went through similar hard times. It was then that she realized if she spent more money on advertising and buying display cases to showcase her jewelry around the mall where she worked, she might be able to entice more customers into her store.

You see, Kate hoped that by putting more money into her store, she would increase sales enough to pay for the money she was spending on advertisement and display cases. Kate was partaking in deficit financing.

Deficit Financing Defined

So you might be wondering, what exactly is deficit financing? How does the government play a role in this practice? Deficit financing is a policy where the government finances expenditures (large spending) via borrowing money instead of increasing taxes. When the government is faced with a budget deficit because there is a gap between public revenue and public expenditure, deficit financing begins.

In simpler terms, when the government spends more money than it gets back, they look for options to make up the difference,which we will learn about in the following section.

How Does a Government Fix Budget Problems?

Like mentioned earlier, deficit financing occurs when a government spends more money then it is taking in. But, sometimes countries borrow money from foreign creditors when their markets are undeveloped,which in doing so, they create a financial deficit as well. This is because, in order to enhance economic growth, the government does not have the backing of private investors and, thus, has to find means to fund the growth themselves.

Which ever way a government creates a deficit, though, they need to find ways to fix it. So how do they do it? Well, sometimes governments find it easier to print more money than to increase taxes to cover the deficit. Obviously, the public does not like when they have to pay more taxes and may even push back on the idea of increasing the tax rates. This then leads to the government printing more money, known as minting.

Problems with Deficit Financing

Because deficit financing is a complex topic, lets look at some of the problems that can occur.

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