Blog: Fiscal Deficits Are Good For You

Published: March 02, 2015 12:35 IST

(Aunindyo Chakravarty is senior managing editor, NDTV India and NDTV Profit)

We have all been told that it is best to spend less than what you earn. But in practice, most of us don't do that. We take home loans, buy cars on EMI and sometimes even use our credit cards, knowing we might not be able to pay the entire bill in the coming month. As long as people earn enough to pay their EMIs and their credit card bills regularly, taking loans is actually not a bad thing at all.

What's true for you and me is even truer for corporates and entrepreneurs. The biggest companies you know all took loans to expand their business, produce more and capture the market they are in. Of course, only those who earned enough to pay back their loans managed to survive and become big.

So the caveat to taking loans to spend more than you earn seems to be this - make sure you earn enough in the future to be able to pay back your loans and the interest on them.

The same holds true for nations as well. Governments habitually spend more than the taxes they earn. There's nothing wrong with this, especially when the economy is doing badly and public spending can help revive demand.

Public money is usually spent on building roads, bridges, dams, power stations and other infrastructure projects. Public spending can provide business to project-starved engineering and construction companies. They in turn, will buy cement, steel, machines, employ engineers and construction workers. The newly-employed will then spend their salaries on food, soaps, cars, fridges and many other things that we all buy.

Public money can also be spent directly to subsidise those who don't earn enough. If the poor get cheap food, they can spend what little they earn on other things. That, again, generates demand for lower-end products like cheap soaps, torches, biscuits.

The extra earning by companies and by consumers can lead to higher tax earnings for the government in subsequent years. So, spending extra in one year could well lead to higher revenues for the government in coming years.

In other words, in times of economic crises, it is actually good for the government to spend more and kick-start the economy. But, what happens to that scary word - the 'Fiscal Deficit'?

In very simple terms, the fiscal deficit is the difference between all that the government earns and what it spends. This not only includes tax revenue, but also dividends earned from government-owned companies.

Just as we have to take loans and sell property or stock to fill the gap or 'deficit' between what we earn and spend, the government too needs to finance the fiscal deficit. It does so by taking loans from the public (bonds) or from institutions. It also raises money by selling assets it owns, such as stake in public sector companies (disinvestment).

But while the loans that you and I take cannot make a difference to interest rates in the economy, governments are such big borrowers that if they borrow too much, they can push interest rates up. That is one reason why most economists are against governments running high deficits.

Unlike you and me, the government can also finance its fiscal deficit by simply printing money. Most economists hate that even more than taking loans. They say printing money simply means 'more money is chasing the same amount of goods'. That can only mean inflation.

Some economists, however, say this argument only holds true if an economy is running at full capacity - that is, every factory is producing all that it can produce. In crisis situations, like the one that we are in right now, when capacity utilisation is low, the extra money printed by the government will simply help raise production without any impact on prices.

Let me explain this a little more. If the extra money printed goes into the hands of those who did not have enough money to buy goods and services, their consumption will go up. Factories which had cut back on production will now raise their output. This could actually push down costs of production because machines and workers will be better utilised. So, instead of raising prices, printing money could do exactly the opposite.

So the received wisdom we have been living with all these years that says fiscal deficit is a bad thing might well be entirely wrong for crisis economies. Arun Jaitley appeared to be breaking with this 'fiscal fundamentalism' in his budget speech when he said "public investment needs to step in to catalyse investment." He also said "rushing into, or insisting on, a pre-set time-table for fiscal consolidation pro-cyclically would, in my opinion, not be pro-growth."

He should have gone all out and pushed for a higher fiscal deficit next year than this year. Instead, he made a minor concession of pushing back the fiscal consolidation timeline by one year. Perhaps, that is why the real numbers in the budget fly in the face of Mr Jaitley's speech. Fiscal fundamentalism has prevailed, and public spending has been cut drastically, rather than being increased.

(Disclaimer: The opinions expressed within this article are the personal opinions of the author. NDTV is not responsible for the accuracy, completeness, suitability, or validity of any information on this article. All information is provided on an as-is basis. The information, facts or opinions appearing in the article do not reflect the views of NDTV and NDTV does not assume any responsibility or liability for the same.)

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