P x T M x V

Where:

In this equation, P x T represents the total economic output, whereas M x V depicts the total demand in the economy. This relationship helps us understand that the size of the economy (P x T) is driven by the interaction between the money supply (M) and the velocity of money (V).

The Role of Productive Expenditure

Maintaining a low fiscal deficit does not necessarily translate to high economic growth. The critical factor is how money is spent. Effective spending should lead to the creation of tangible assets and services, fostering overall employment opportunities. This perspective contrasts sharply with the UPA regime, where a majority of the money was spent without generating visible progress or benefits, as indicated by numerous road repairs and maintenance projects in urban areas that remained in poor condition despite significant investment records.

Understanding Fiscal Surplus or Deficit

Fiscal surplus or deficit can be defined by the equation:

Revenue - (capital expenditure transfers) fiscal surplus or deficit

In developing economies, a high fiscal deficit caused by increasing transfers (such as subsidies or schemes like NREGA) can pose significant risks. However, capital expenditure on infrastructure projects aimed at supporting micro, small, and medium-sized enterprises (MSMEs) can be beneficial. Developing countries often require additional funding to support investments in infrastructure, which is justified on the basis of the greater economic potential and capacity for growth.

The Implications of Inflation and Money Supply

The relationship between fiscal deficit and inflation is especially relevant in developing countries. The equation of exchange, P x T M x V, highlights the importance of money supply and velocity of money. In developing nations, there is a higher likelihood that increased money supply can lead to growth, even if the velocity of money is relatively fixed. This is because the demand for consumption and investment is often insufficient to be met by existing money supply, thereby justifying the use of debt to finance such growth.

Government Debt and Compiled Spending

Why do governments opt for high fiscal deficits? Part of the answer lies in the advantage of using government funds and retirement or insurance funds to invest in financial instruments with minimal risk. Additionally, governments can utilize long-term debt to finance infrastructure projects that promise sustainable returns. The example of the United States demonstrates how governments can efficiently manage debt, often paying a rate that is significantly below the average.

In India, the fiscal deficit impacts are more pronounced. The high allocation of the budget towards interest payments on loans (18%) highlights the inefficiency of this expenditure. If people were to lend money to a borrower who commits to repaying 18% of their income on interest, there would be very few takers. This situation explains why Indian government securities are still in high demand, even as the country can potentially face defaults and lacks a robust secondary market for securities trading.

Conclusion

While maintaining a low fiscal deficit is generally acknowledged for economic stability, the effectiveness of such deficits hinges on how revenues are spent. High fiscal deficits can be justified in developing economies when the expenditure is directed towards productive and beneficial investments. Understanding the relationship between fiscal deficit, the equation of exchange, and the dynamics of money supply is crucial for policymakers seeking to drive sustainable and inclusive growth.