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Internal borrowing may affect firms since they also require finance and it may be that individuals and financial institutions prefer to lend the government where the risk is less and possibly returns are greater. Thus, the public sector may ‘crowd out’ the private sector. This is also known as ‘crowding out effect’ which refers to the rise in private investment due to deficit spending by government. Deficit spending leads to high interest rate which discourages private investment.
Government borrowing can affect economic growth because it will tend to raise the rate of interest hence this increase in rate of interest will make capital investment less profitable resulting in a fall in investment, slower economic growth and reduction in the competitiveness of the industries.
Government borrowing may lead to crowding out effect; the possible tendency for government spending on goods and services to put upward pressure on interest rates, borrow at high rate of interest curtail their investment and consumption spending.
The increase in interest rate will raise the rate of cost of borrowing money for the purchase of houses and other goods hence an increase in the cost of living leading to inflationary pressure.
Investors confidence is undermined; investors anticipate that the huge debt would one time be paid painfully. They therefore fear to be victims during that time.
Continuous debt accumulation exposes the country to difficult times ahead if borrowing spree is not controlled and repayment becomes difficult.
To avoid the above effects;
i. The government would borrow from the banking system by use of treasury bills.
ii. Growing out of debt that is by enhancing economic growth; this will enable the country generate government revenue which in turn reduces the burden of debt (the service relative to its income)
iii. The problem created by austerity measures should be managed.
iv. Debt re-structuring (dealing with the problem of syndication; reducing the number of banks which lend to the government hence dealing with interest.
v. Restoring to savings.
Dullayo answered the question on April 22, 2018 at 09:34
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Read the following summaries of the financial situation and goals of two of your friends:
Kathy
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Jackson
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