Answer to Question #131412 in Macroeconomics for Balungile Manakele

Question

The increased government spending noted in Q.3.1. above has to be financed in
one way or another.
Describe three ways in which government spending can be financed.

Answer 1

Government spending can be financed by taxation, borrowing, and by printing money.

Taxation - tax revenue is the largest source of government revenue. The government levies income tax, corporate tax, excise tax, import duty, and more. Taxation forces individuals and corporates to contribute towards government revenue. When there is a budget deficit, the government can increase tax rates so as to increase revenue.

Borrowing - government can borrow domestically or internationally. The government mainly issues treasury bills, guilt edged securities, to raise revenue by borrowing from individuals and corporates, both locally and internationally. Governments can also borrow from friend countries, regional banks such as the European Central Bank (ECB), and from international financial institutions such as the international monetary fund (IMF).

Printing money - governments can also print money, notes and coins, and put it in the government account with the central bank. Printing money increases government revenue. However, this method has severe risk of fueling demand pull inflation by causing excess liquidity in the economy as money supply increases.