Invitation : Attend OPEN Classes on Current Affairs for Mains 2017 on 16th & 17th at 11AM

Walk in to the Test Center at 11AM Today or Register for the 2 Days Open Classes, or enroll for the ONLINE / OFFLINE Current Affairs for Mains 2017 by visiting the below link http://blog.forumias.com/currentaffairs2017. A registration fee of Rs. 50/day is charged for the two day event to have a correct estimate of the number of people attending.

What is the relation between deficit spending and interest rates?

Please explain
Delay Gratification
·

Comments

  • edited July 26

    Both are inversely proportional.

    Take the example of USA post 2008 crisis. Their economy was facing recession and needed a push therefore they started their new monetary policy of quantitative easing.

    Here low interest rates were set by the Fed. This allowed the US govt, industries and individuals to borrow at cheap rates so that some kind of stimulus could be provided to the economy. It was hoped that this deficit finance(cheap money) would ultimately fuel increased aggregate demand, consumption, investment, output and growth.

    Now 9 years down the line since the global economy is back on track, the federal reserve is increasing interest rates again so that inflation is kept under control.

    Hope it helps
    ·
  • edited July 26
    Did you try searching on google and wiki? Just suggesting cause when you first explore yourself you will get better idea about such topics.

    Anyway, see the relation is simple. Deficit spending is done by the government in various situations, mostly when it needs to spend more than it earns from its revenue sources. (It is not very good practice if it is unsustainable, or it is being used to finance committed/revenue expenditure. Cause simply you wouldn't survive if you keep spending more than you are earning.)

    So how government gets its money to finance its fiscal deficit? One option is borrowing from the market. (By issuing government bonds etc.) So when government becomes major player in borrowing, it crowds out other private players (who are more efficient in capital investment). This heavy intervention of government creates scarcity of liquidity/resources in the economy and when something is scarce its value rises. Thus value of money/loan rises for all players.

    Thus deficit spending gives rise to higher interest rate. And other negative consequence if spending is on farzi non productive schemes etc.

    Edit: Adding some pointers to explore
    https://en.wikipedia.org/wiki/Deficit_spending#Crowding_out
    http://www.investopedia.com/terms/c/crowdingouteffect.asp
    ·
  • Thanks. My doubt was from this article, http://blog.forumias.com/inflation-and-its-impact-on-indian-economy/ .

    I couldn't understand this statement, "High deficit spending is not compatible with lower interest rates."
    Delay Gratification
    ·
  • edited July 26

    Thanks. My doubt was from this article, http://blog.forumias.com/inflation-and-its-impact-on-indian-economy/ .

    I couldn't understand this statement, "High deficit spending is not compatible with lower interest rates."

    Yeah.. Either you control interest rate or inflation, in case of high deficit financing. You cant control both.
    Hope now you get the link between these three variables i.e. Deficit financing, interest rate, and inflation.
    ( cause deficit financing can also be achieved by prinitng money, which might control interest rate but will surely lead to inflationary pressure)
    ·
  • edited July 26
    Think of govt too as an individual. Anyone spending beyond capacity creates excess demand. With supply being constant, it is bound to create inflation. Excessive inflation necessitates higher interest rates to control the excess spending capacity, thus
    reducing demand, thus reducing inflation. Hence deficit spending incompatible with lower interest rates.
    As per my understanding.
    Prelims: 4, Mains: 2*, Interview: 1
    No rank yet.
    ·
Sign In or Join to comment.

Courses by ForumIAS for CSE
ForumIAS is trusted by over 10,000+ students for their Prelims, Mains and Interview Preparation and we currently run several assistance programs to help students from Civil Services prelims preparation to rank upgradation to IAS. You can enroll for these programs by making the payment through the links below

1. Mains Guidance Program 2017 - July 1st : Batch C ( 24 Seats | 21 GS + Essay Tests ) | Test Plan | Payment Link |
2. Mains Guidance Program 2017 - 7th August : Batch D ( 50 Seats| 8 GS Tests ) | Test Plan | Payment Link
3. Current Affairs Classes for Mains 2017 (OFFLINE) - 16th August - ( 200 Issues for Mains 2017 ) | Class Plan | Enrollment Link
4. Current Affairs (Online) Classes for Mains 2017 - 20th August | Details | Enrollment Link
5. Prelims Test Series 2018 - Coming Soon 6. Mains Guidance Program for Mains 2018 - Coming soon

UPCOMING EVENTS by ForumIAS
1. Open Session on DAF Filling : What you fill in your Detailed Application form, will decide the marks you get in the Interview, the service that you will get and the state you will live in , for the rest of your life. Last but not the least, it will also decide who you will marry. Don't make mistakes. Join us for an open session on filling up the DAF. We will be assisted by ForumIAS Members who have secured a service or rank in this initiative.

Welcome!

We are a secret self-moderated community for Civil Services preparation. Feel free to join, start a discussion, answer a question or just to say Thank you.

Just dont spread the word ;)

Sign in or join with Facebook or Google

Subscribe to ForumIAS Blog