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Fiscal Management

6

Understanding Fiscal Management

The Problem of Public Debt Issuance

Government spending may be financed by taxes or public debt issuance. Government deficit is the difference between tax revenue and spending. The deficit is financed by public debt issuance, which involves borrowing money from the private sector. Many developed countries, including Japan, have suffered from fiscal deficits for many years. They have accumulated a large amount of public debt outstanding. In this chapter, we investigate the positive and normative aspects of fiscal management with deficits and public debt issuance, based on the analytical results of prior chapters.

Many people believe that fiscal deficits and public debt issuance are harmful in themselves. The fiscal authority usually considers that the target of fiscal consolidation is the elimination of fiscal deficits and the cessation of the new issuance of public debt simply because public debt can create bad and serious outcomes. In this context, it is said that there are several difficulties with regard to public debt. Among them, the following are the most notable.

  • (i) Public debt issuance crowds out private investment and/or consumption demand by raising the rate of interest, as explained in Chap. 2. If the government intends to avoid the crowding-out effect and rely on money finance, the likely result is hyperinflation due to excessive money supply.
  • (ii) Deficit-covering debt issuance moves the fiscal burden to future generations and hurts intergenerational equity. Since deficit-covering bonds are used for government consumption, they do not provide benefits for future generations. Thus, in contrast to construction bonds, which are used for public investment, deficit-covering bonds simply move the burden to future generations without any benefits. Moreover, the benefit of construction bonds is not so significant

© Springer Science+Business Media Singapore 2017

T. Ihori, Principles of Public Finance, Springer Texts in Business and Economics, DOI 10.1007/978-981-10-2389-7_6

if the productivity of public investment is low. Then, even construction bonds do not provide a net benefit for future generations.

  • (iii) A large amount of public debt issuance results in a large amount of debt redemption and interest payments, a situation that impairs the flexibility of fiscal management on budgeting. In particular, refunding deficit-covering bonds induces further refunding by enlarging the size of the deficit. This may lead to a vicious circle of refunding.
  • (iv) Under political pressure in a democratic country, debt finance is more easily conducted than tax finance. Voters do not accept an increase in taxes in any situation. As a result, fiscal discipline is harmed, inducing larger wasteful spending and larger deficits.
 
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