Three Ways to Finance Deficit
There are three ways by which the central government finances deficit. These are:
(a) Borrowing from Public and Foreign Governments
(b) Withdrawing Cash Balances held with the Reserve Bank of India (R.B.I.)
(c) Borrowing from the Reserve Bank of India (R.B.I)
The Government ordinarily prefers to borrow either from its citizens or from foreign governments instead of withdrawing cash balances held with the R.B.I. or borrowing from it. The latter two ways to finance deficit increase the supply of money. The increase in supply of money increases the prices in an economy. On the other hand, borrowing domestically from public has no effect on the supply of money and consequently on prices because when government borrows, the money held by people is transferred to government with no change in the supply of money. However, the money supply would increase when government borrows from foreign countries. The last two ways to finance deficit increase the supply of money. Any money that flows out of the R.B.I. increases the supply of money in economy and increases the prices in domestic economy
