Question about budget (1 Viewer)

[rrlm910]

2009 HSC
Q22b. Examine the likely impact on the economy if the government finances a budget deficit by borrowing from the domestic private sector.

Could anyone explain this one to me ?

 

[krnofdrg]

2009 HSC
Q22b. Examine the likely impact on the economy if the government finances a budget deficit by borrowing from the domestic private sector.

Could anyone explain this one to me ?

The government can borrow from the domestic private sector by selling new Commonwealth government secruities in domestic financial markets. This is known as deficit, bond or debt financing and requires the government to pay the money back in the future with interest.

SO the gov will sell bonds through a tender system, value of bonds are determined according to the budget deficit and buyers but them at a certain interest rate.

However impact on the economy is it may cause a rise in interest rates and 'crowding out' of private investment. This means selling gov. secruities will only be succesful if the i/r is offered competitively at market interest rates with other securities.

Higher i/r dampens economic activity by reducing aggregate demand, it costs more for businesses to undertake investment (AD=C+I+G+(X-M)) -> I falls

Higher interest rates lead to also increase capital inflow (higher value of AUD, APPRECIATION), which reduces international competiveness of AUS exports. which has multiple ramifications on the economy.

This also leads to higher spending on imports at the expensive of imports called the process of 'international crowding out'.

Deficit financing from domestic private sector also leads to the accumulation of national debt by the gov and sets up future financial obligations through payments of puiblic debt interest..

So financing a budget from the domestic private sector has multiple ramifications however it avoids net foreign debt from being accumulated.

 

[rrlm910]

thanks heaps man , also one thing... what exactly is the government securities and what do people do with them when they buy them? is it money or..? I never understood this :/

 

[krnofdrg]

thanks heaps man , also one thing... what exactly is the government securities and what do people do with them when they buy them? is it money or..? I never understood this :/

Basically a type of investment.

A government bond is a bond issued by a national government denominated in the country's own currency. Bonds/securities are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to the company or country.

So people buy them from gov, and they get an interest later on with it