Methods of financing deficits

Borrowing from the private sector

The main form of deficit financing is through the domestic selling of Treasury bonds (debt financing)

• Where Investors (private sector) lend money by purchasing these bonds

  • with the ability to sell these bonds back to the government at a later date, collecting interest

• considered low-risk to investors (backed by government)

  • Australian bonds have historically never defaulted

• However, this can lead to the crowding out effect

  • an upwards pressure on interest rates as less money is invested in banks (private sector)
    • private sector (banks) may need to then borrow overseas
      • → adds to CAD

• The crowding out effect occurs where :: government spending is financed through borrowing from the private sector, which puts upward pressure on interest rates and “crowds out” private sector investors who cannot borrow at the higher rates of interest.

Other Methods

Borrowing from overseas

• The RBA sells government securities to foreign investors

  • accumulating foreign debt
  • may minimise the crowding out effect as it increases the money supply for the private sector

• Additionally, more foreign debt renders the government more susceptible to exchange rate fluctuations

  • (valuation effect)

• if the budget is ‘irreparable’ it could borrow from the IMF

  • this position is very unlikely to occur.

Borrowing from the RBA (monetary financing/Quantitative easing)

The Government may simply borrow from the Reserve Bank to finance the deficit (“monetising the deficit”)

• Done by selling gov securities to the RBA
• hasn’t been employed since 1982
• This amounts to the Government printing more money to finance its expenses.
  • → increases money supply → increases inflation etc…****

Selling assets

The selling of government assets can fund a deficit

• (such as selling Commonwealth land, or the Commonwealth’s share in businesses like Aus Post, etc.)

• does not reduce the underlying cash deficit or the net operating deficit (as it’s a one-off transaction)

• The financial burden is shifted from the public to the private sector.

Using budget surpluses

• Pay off retiring public debt: will reduce future debt obligations, as interest repayments become lower, minimising future expenditure

• Reduced foreign debt: will reduce interest payable and the size of NPY deficit, hence reducing the CAD and overall foreign debt levels

• Government owned investment funds: invested into gov managed funds used for future expenditure

  • (e.g. the Future Fund helps cover superannuation liabilities)

Public sector borrowing and debt

This header is only mentioned in textbook, likely unimportant

Public Sector Cash Outcome: Reflects the borrowing needs or surplus funds from all government levels; comprehensive indicator of public sector impact on the economy.