Government Borrowing: Monetary Theory and Policy - Assignment Example

? Government Borrowing Government Borrowing Introduction The government of Canada recorded net lending and borrowing at -77.61 billions Canadian Dollars in the year 2009. This is according to International Monetary Fund (IMF). Canadian government projects that net lending and borrowing will be 0.26 billions Canadian Dollar in the year 2015. Usually the government exercises its borrowing authority when there is a shortfall between its expenditure. This occurs after Canadian Parliament authorizes the government to do so through main and supplementary estimates and in interim supply, and its revenues. The government borrows majorly through issuing treasury bills, Canada Savings Bonds, and marketable bonds in domestic and foreign markets. The Financial Administration Act dictates that Governor in Council has the mandate to authorize the Minister to borrow money on behalf of Her Majesty in the right of Canada. The government borrowing has been too high and the interest is very low. The government Canada reported a net debt of approximately $ 616.9 billion in the fiscal year 2010-11. This was a rise by $ 34.4 billion from 2009-10. Canada’s total government net debt-to-GDP ratio hit 30.4 per cent in the year 2010 (Department of Finance of Canada, 2012). This paper will explore the issue of high government borrowing and low interest rates. It will give economic measures to tackle the problem in Canada. The level of government borrowing is crucial ingredient of fiscal policy and management of aggregate demand in any economy. When an individual government runs a budget deficit, it implies that in that fiscal year, total government spending exceeds total tax revenue. When a government experiences a deficit in its budget estimates, it has to borrow in order to bridge the gap. This forces the government to issue its debt as Treasury Bills and long-term government bonds through central bank. The negative effects of Canadian government’s high borrowing are duplicated in the in the financial statements of the country. In the 31 March 2011, the Department of Finance of Canada announced that interest-bearing debt was $ 801.8 billion. This was an increase by $ 39.0 billion from the year 2010. Similarly, the un-matured debt was higher by 32.0 Canadian dollars. In addition, liabilities for pension and other benefits for employees went higher by 7.3 billion Canadian dollars. Increase in government borrowing through issuing of bonds such as treasury bills and securities to pay interest in fixed period or indefinitely (Department of Finance of Canada, 2012). Canada has not registered positive results fiscal stimulus. The economic stimulus seems it is not effective. The government borrowing has led to low interest rates making government run a budget deficit. In addition, fiscal stimulus has demonstrated inflationary effects that results from high demand. Fiscal stimulus entails the proposition that through borrowing money and spending it, the government can raise the state of economy. This is through raising inputs and lowering the numbers of jobless. Fiscal stimulus can increase aggregate demand. Theoretically, printing money can be a form of fiscal stimulus. This is because money counts as a transfer payment. People will have a lot of money because of increased printing. However, in practice people do not just keep many dollars of their extra cash. People will spend the extra amount of money creating demand for services and goods. The increased aggregate demand leads to inflation. This is the state bedeviling Canada. The high borrowing of government seems to create problems rather than to develop economy in Canada. When the government borrows money from private sector this corresponds to increase in spending on its part. However, government borrowing limits the spending of private sector. This therefore implies that job opportunities, which fiscal stimulus seeks to created are offset through decline in private spending. Canada is grappling with the same situation. Too much borrowing seems to impair the government’s ability to deliver crucial services to the citizens of Canada. Accumulation of debt involves risk. This is because debt has disruptive consequences on the financial cycles. Economies alternate between credit-fuelled booms and default-driven busts. High busts collapse the economy of a country (Madura, 2012). Fiscal policy seems not to work in Canada. This is because the fiscal policies have potential problems such as crowding out effects. Crowding out threatens the growth of private sector. The consumption spending of private sector falls because of increased government expenditures and subsequent budget deficits. The higher interest rates generate higher interest rates that lead to decline in private spending. For instance, Canadian government borrowing many funds to finance its deficit raises the total demand for funds. This is because competition sets in between government and private sector to borrow the available money. The additional government borrowing increases demand for money thereby raising the rates of interest to a higher level. High interest rates will cause businesses to delay their activities and consumers to shun away from purchasing interest sensitive goods. The overall effects of crowding out are to reduce the effectiveness of fiscal policy (Walsh, 2003). The government of Canada can devise prudent measures to eliminate its high rates of borrowing and inflation. Sound measures such as direct intervention and income policy can greatly lower inflation in Canada. Government should take precautionary measures to prevent rampant increase in prices and income. For instance, government can freeze wage increase and prices directly (Greer, 2005). Similarly, government of Canada can persuade many firms to adopt smaller packages of wages and prices. Government of Canada can also reduce inflation through decreasing its expenditure and increasing taxes. This will solve the aggregate demand of funds that result from increased rate of borrowing. When reduction of expenditure augments with monetary policy, it gives a practical solution to inflation in Canada. Monetary policies entail control of interest rates and setting guidelines to raise the value of money (Greer, 2005). Appreciation of money will deter the government of Canada from over borrowing. The government of Canada should stop all spending that does not get funds tax and nontax revenues. This is because such spending leads to excess aggregate demand and eventually inflation. Creation of money through fiscal stimulus does not help to solve problems bedeviling Canada. The government should expand money supply in noninflationary way in order to meet increasing demand of money. Canada should adopt fiscal policy that encourages saving and investment instead of borrowing. This promises to yield well towards the growth of economy in long-terms. Continued borrowing does not save the economy of Canada. This is because when consumption exceeds the current revenue it dooms economic growth of Canada. High responsiveness to domestic expansion on output and capacity to balance position of payments are sound strategies to achieve positive results of economy in Canada (International Monetary Fund, 2012). On top of this, Canada should concentrate on increasing prices of goods that have an international demand. This will lead to foreign trade leading to excesses in government revenue. References Cochrane, J. (2009). Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?. Retrieved 06 June 2012, from http://faculty.chicagobooth.edu/john.cochrane/research/papers/fiscal2.htm. Department of Finance of Canada (2012). Annual Financial Report of the Government of Canada Fiscal Year 2010-2011. Retrieved 06 June 2012, from http://www.fin.gc.ca/afr-rfa/2011/report-rapport-eng.asp. Greer, R. (2005). The Handbook of Inflation Hedging Investments: Enhance Performance And Protect Your Portfolio from Inflation Risk. New York: McGraw Hill Professional. International Monetary Fund (2012). Guidelines for Fiscal Adjustment. Retrieved 06 June 2012 from http://www.imf.org/external/pubs/ft/pam/pam49/pam4901.htm. Madura, J. (2012). Financial Markets and Institutions. New York: Cengage Learning. Parliament of Canada (2009). House of Commons Procedures and Practice. Retrieved 06 June 2012, from http://www.parl.gc.ca/procedure-book-livre/Document.aspx?Language=E&Mode=1&sbdid=F26EB116-B0B6-490C-B410-33D985BC9B6B&sbpid=E9FCEF2D-9C74-4FFF-A31B-66B08AE2A5F8. Walsh, C. (2003). Monetary Theory and Policy, Part 5; Parts 199-216. New York: MIT Press. Read More