Impact of government spending on economic growth, Macroeconomics Video Lecture | Macro Economics - B Com

let us understand the role of government
spending and its impact on an economy to
understand the role of government
spending and its impact on an economy we
have to first understand from where does
the government earn its money and how
does the government spend its money
there are two main sources for the
government to earn its money the first
and the biggest source are taxes the
government taxes a lot of things such as
income of individuals via income tax
profits of corporations by corporation
tax and host of several indirect taxes
like sales tax and service tax these
taxes together contribute the biggest
source of income for a government the
second source of income for the
government are non-tax revenues non-tax
revenues are income where the gap which
the government makes from its public
sector undertakings so for example in
India the Indian government owns the
Indian Railways so any profits made by
the Indian Railways is a source of
revenue for the government similarly the
government is a our share is shareholder
in several public sector banks when
these public sector banks make profits
and pay dividends that is also a source
of revenue for the government but this
is non tax with these two main sources
of income from the government let us
understand where does the government
spend its money the expenditure of the
government can be classified into two
categories revenue expenditure and
capital expenditure revenue expenditure
is the expenditure which the government
has to incur for its functioning so for
example paying of salaries of government
employees allocation of money to several
ministries so all these are part of the
expenditure which the government has to
for its mood functioning there is the
other sort of expenditure which is the
capital expenditure capital expenditure
is a bit different because this leads to
formations of asset in the economy so
when the government spends money to
build roads bridges rail lines hospitals
or schools this can be seen as capital
expenditure because this is leading to
asset formation in the country so now
that we have seen the two main sources
of income for the government and the two
main sources of expenditure for the
government we need to understand what is
a deficit now it so happens that in
certain years in some years the
government spends more money than it
earns when the government spends more
money than its earns then the question
is from where does the government get
that extra money so hypothetically
speaking if the government earns hundred
from taxes and spends 150 from where
does the government get that 50 and the
answer is that the government
essentially borrows that money it bought
it can borrow the money from the central
bank there is a reserve in India they
could the government of India can borrow
from the Reserve Bank of India all they
can borrow directly from the market now
when the government spends more than it
earns when the total expenditure the
revenue expenditure and the capital
expenditure is more than what the
government earns the government is known
to be running a deficit now fiscal
deficit if kept under a certain is kept
if kept under a check is not necessarily
a bad thing because if the government is
mostly spending money in capital
expenditures even though it is running a
deficit the government is leading is is
is playing the role of creating assets
in the economy these assets in the
economy will give returns in the long
run so even though the government is
running a deficit and is borrowing money
if it is spending most of its money in
capital expenditures in asset formations
these assets are likely to bear fruit in
the near are the middle in the medium
future medium-term future however if the
fiscal deficit is not kept on the check
and if the government spends way too
much money than what it earns then
things can get a bit problematic let us
understand what problems can a
government face or what problems can an
economy face because of a very high
fiscal deficit the problems that an
economy faces are high inflation higher
interest rates and in some cases higher
taxes because of high fiscal deficit let
us understand each of them one by one
when the government borrows money let's
let's talk about high inflation first
when the government borrows money if the
government borrows money from the
central bank then the central bank has
to print new money to lend it to the
government if the central bank prints
new money and lends it to the government
this increases the total money supply in
the economy and the goods and services
remaining constant increase in money
supply will cause an increase in prices
so this leads to high inflation secondly
because the government is spending a lot
of money
this increases aggregate demand in the
economy if for some reason the supply
cannot increase to match up to that
aggregate demand then the prices will
increase there could be certain factors
which might be inhibiting the economy
from increasing its supply because of
certain constraints and the factors of
production in such a scenario if the
government is spending a lot of money it
is increasing the aggregate demand and
the government is increasing the
aggregate demand and supply not being
able to match up will lead to an
increase in prices and hence high
inflation let us take the case of high
interest rates
how does fiscal deficit cause higher
interest
if the government of India does not
borrow from the central bank
but borrows from the market directly
which is generally the case in India
when the government of India runs the
deficit they generally borrow from the
market by issuing Government of India
bonds when the government issues bonds
in the market they are acting as a
source of investment for many investors
out there when investors see government
issuing bonds some of the investors
might be willing to invest in the
Government of India bonds hence the
government of India is issuing financial
securities which is competing against
the other sources of investments that
are there in the economy the fixed
deposits the post topic savings are the
deposits by by banks so all these other
sources of investments have found a new
competitor when the government enters
the market and try starts selling its
bonds so for these other sources of
investments to keep their customers with
themselves they have to pay a higher
interest rates when the Institute's when
the financial institutions and the
financial industry has to pay higher
interest rates when they raise their
interest rates that causes the cost of
capital to increase in the economy if
the cost of capital starts increasing a
lot in the economy that can be
problematic for economic growth because
cheap capital is something that is
necessary if capital becomes expensive
that will hinder investments because
people might not be investors might not
be willing to borrow money and hence
investment opportunities will become
scarce because capital has become
expensive and only those investment
opportunities which are providing which
are promising a very high return
investors will only be willing to borrow
money to finance a very profitable
investment opportunities and if that is
the case the economic growth in the
country takes a hit
so that's this is how we saw where
fiscal deficit causes high interest
rates which can in certain cases have
detrimental effect on the economy in
some cases in certain dire situations
where the government is running a very
high official deficit then the
government might be forced to increase
their taxes to increase their income if
so the government is forced to increase
the taxes on their citizens or on the
economy to increase its income and
increase in taxes can have several
cascading effects it can affect
consumption levels it can affect
investment decisions and hence that can
also in some cases have detrimental
effects on the economy so we see that
this fiscal deficit figure is very
important because very high fiscal
deficits has detrimental effects on the
economy India as a country has always
had a fiscal deficit in certain years
our fiscal deficits becomes
uncomfortably high and hence the
government then starts taking measures
to bring down their fiscal deficit what
is the role of government in economy in
an economy the government plays a very
critical and crucial role the first of
them is that the government it is it is
the onus of the government to provide a
well-functioning legal and political
system a economy a government or a
society which is experiencing political
turmoil a violent political turmoil is
not conducive for economic growth
because there is very little trust in
the system there is a lot of uncertainty
and people are unwilling to invest
hence governments need to make sure that
the country has a stable political
environment which is very important for
the confidence level required for people
to invest and increase the economic
activity in a country
what is also necessary is that a
government provide a good legal
framework
because when people invest or enter into
contracts with each other they are bound
to be cases where certain counterparties
renege on their promises on the on the
on the terms and conditions of the
contract therefore contract enforcement
becomes very critical in a developed
economic world it is also the owners of
the government to provide such a
contract enforcement mechanism via the
legal framework so this providing a
well-functioning legal and political
system is very important it is a very
important role the government plays in
the up in the advancement of an economy
secondly the government plays the the
other crucial role of being the sole
being the regulator and to provide a
competitive marketplace markets are not
completely free as some free market here
philosophers are free marketeers think
thinkers would like it to be there needs
to be certain checks and balances put in
place there needs to be certain amount
of regulation to ensure that this the
economy or the society does not drift
towards monopolistic situations hence
there needs to be a proper regulatory
framework as well
regulation in in certain sectors like
the telecom or insurance are a few
examples that we have in our country
India the government also needs to think
about policies when it comes to trade
with foreign countries national economic
policies the government also decides on
the the regulation to put in on the
natural resources available in a
particular country
hence the regulatory role is also
critical in case the the regulatory role
is also critical when it comes to
the economic environment in a particular
country the government regulates the
marketplace and tries to ensure a
healthy competitive marketplace for the
goods and services that are transacted
in a country in certain cases and this
in certain cases it is important that
the government the government stimulate
the economy by increasing spending this
is this was one of the philosophies
which was put forward by the renowned
economist John Maynard Keynes where he
saw that the government role the
government's role becomes very critical
in case of situations where the economy
is in recession or is always suffering
from from from a depression like
scenario in this case he argued that the
government's should increase their
spending to pick up the economic
activity in a particular country the
government also has the owners of trying
to keep income inequality in check
hi this great disparity in income
equality in in income levels within a
particular society can lead to a certain
amount of unread a certain amount of
unrest if there's a large population
which has very little resources or very
little wealth and there's a there's a
very small minor population which has
huge amounts of wealth and resources
that can lead to certain political
instability but and that is also not
conducive for future economic growth
because the huge inequalities creates
some disbalances in the goods market and
the capital markets as well hence the
government needs to provide schemes and
policies via taxes or wire some social
spending whereby they keep this
inequality in check these are the key
roles that the government plays in an
economy we are going to look into in
later videos we are going to look in
how does the government finance some of
its spendings and where does the
government earn its money and how does
it spend its money