Financing a deficit and crowding out

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In this video we’re going to be looking at how the government will finance the public services and waiting by the plan crowding in and crowding out in this video so first of all if the government longer budget deficit it has three options so a budget deficit means expenses exceed revenue the government must do one of three things it can one borrow from the rba it

Can to borrow of a private sector what i mean by that is generally australian banks and financial institutions or it can borrow for money from overseas if they choose option three that the thing is going to increase our level of national debt or government debt they mean the same thing so first option they borrow from the rba the government will basically issue

Bonds or i use the rba and the rba will print more money so basically this first option just means the government print more money or they increase the money supply and just go to the mint and print more cash notes this will directly stimulate economic activity it’s the most expansion airy way to stimulate the budget because involves printing more money which

Can often lead to inflation because there’s more money in circulation the value of money falls and that can lead to excessive inflation the borrowing from the rba is very unpopular because it can reduce the real value of money and it can mean that people’s incomes are worth as much which is very unpopular so far in from the rba of the most expansion arey at least

Relevant now because it’s very rarely used second option click a borrow from the private sector borrow from but they do this by selling different securities or bonds to the private sector so they basically ask the private sector for money and they sell them government securities or bonds which is like an iou that we’re going to pay them back basically what this is

Equates to is there taking the bank’s money right at this point in time they’re taking the bank’s money for a loan so the banks have less cash and when the banks have less cash they what we call less liquid and because they have less cash they have less and money available to lend to people so if you look at the demand and supply for the bags money they now have less

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Supply of cash so it’s like the supply curve shifting to the left which can lead to a higher price for borrowing money and the term that we refer to when we’re looking at the price of borrowing is the interest rate because the banks now have less cash the government is taking the bank cash that can lead to the bank’s increasing interest rates because they have less

Cash available relative to the demand for their loans so now the bank’s taken all their money they have to increase interest rates on home loans and things like this because they don’t have as much money to lend to people so the problem with budget deficits is there intending to be really expansion airy they’re tending to trying to boost the economy by stimulating

Growth and giving people money but the problem is it can lead to go into the banks which can lead to increase interest rates we can lead to what we call crowding out of the private sector now we know that higher interest rates are bad for our economy because they lead to less discretionary income they can lead to an appreciation of the dot so what happens i’ll just

Go through the whole process the government sells government bonds or security to drop to the banks and takes their cash because the banks now have less cash they raise their interest rates because the demand for their cash outweighs the supply and because the interest rates are now higher people are less likely to spend and that has a contractionary effect on

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The economy so budget deficits that are financed through borrowing from the private sector can have a contractionary impact on the economy because they increase interest rates so creating is crowding out pre government spending or budget deficits causes an increase in interest rates because the banks and less cash which leads to a reduction in investment spending

Because businesses are less willing to take out loans reduction in export demand because the higher interest rates will appreciate the dollar and a reduction in consumption spending because higher interest rates reduce our discretionary income and reduce consumers willingness to borrow that’s crowding out the bank’s basically equates the government taking all the

Bank’s money the bank’s increase interest rates those higher interest rates lead to reduced consumption reduced investment and a higher dollar so trailing at each point the government’s reliance on the banks or financial institutions to fund them decreases the money supply banks have higher demand for their funds and poorer liquidity and less cash so they increase

Their interest rates increased interest rates reduce consumption and investment spending which reduces aggregate demand that’s called crowding out of the private sector the higher interest rates reducing consumption and investment spending because the government has taken all the banks month the higher interest rates also for some local borrowers to follow from

Overseas okay because it is now cheaper and when we borrow from overseas that attracts capital inflow and crowds out the external sector because it appreciates the dollar all these things are having a negative or contractionary effect on our economy because the government’s taking all the bank’s money and therefore they have to raise interest rates again we’re

Just following on here so higher interest rates for some local borrowers to borrow from overseas this is doing free capital inflows and appreciative exchange rates and this crowds out the tradable goods sector because our dollar appreciates export has become less competitive and so important feeding businesses and therefore both the private sector and the external

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Get crap sector get crowded out okay and i know this sounds complicated but all that means the private sector is crowded out because higher interest rates have led to decrease consumption investment and the external sector is being crowded out because the higher dollar has led to less exports and more imports so both of these things will have a contractionary impact

On the economy and therefore the gate some of the expansion effects of the budget would never have you’re explaining creating out again on oh it’s complicated banks take all government take the bank’s money the banks need to increase interest rates the higher interest rates reduce consumption and investment spending and they also appreciate the dollar which crowds

Out the external sector if the government decides to borrow from overseas instead of borrowing from our banks that can that doesn’t have the problem of causing higher interest rates player but it does attract capital inflow because whenever the government borrows money the dollar will appreciate and also increase our net farm debt and the problem with borrowing

From overseas it can increase the cat in the future because we’re going to pay more interest on our foreign debt and it can also lead to crowding out of the external sector because when we borrow from overseas in the short term that attracts capital inflow which appreciates the dollar and reduces demand for exports so even if we borrow from overseas that can have

A contractionary impact because it appreciates the dollar in the short term because of capital inflow and that will reduce demands reacts and walks and increase the demand for importance so regardless if we choose option 2 or option 3 they’re both going to a contractionary impact on the economy through either increasing interest rates or appreciating the dollar

Thank you very much crowding out is important that’s what

Transcribed from video
Financing a deficit and crowding out By Daniel CROWE