Sources of Financing and Money Decomposition

Approaching the first part of the link we try to explain, and ask the question: how it may happen that budget deficits generate movements in money. If the public sector spends more than it receives, such a deficit must somehow be financed in order for the government to pay its bills.

The budget constraint of the government can be expressed as follows[3]:

(1)

Government debt, in the form of either bonds or credits, can be held by the public (domestic and foreign) and by the central bank. Let’s assume for the purposes of the present report that the central bank’s credit to banking system doesn’t alter over time. Then the change in monetary base equals the change in the stock of government debt held by central bank plus the change in foreign exchange reserves , where E stands for the nominal exchange rate, we obtain:

(2)

Equation tells us that in essence, there are three ways to cover a budget deficit:

· by “monetization” of the deficit (i.e. by increasing monetary base or by so called “printing” money);

· by increase in the public’s (foreign and domestic) holdings of debt;

· by running down foreign exchange reserves at the central bank.

According to Ouanes and Thakur (1997), there exist five different ways of financing budget deficit, closely corresponding to the above version:

(i) borrowing from the central bank (or “monetization” of the deficit);

(ii) borrowing from the rest of the banking system;

(iii) borrowing from the domestic non-bank sector;

(iv) borrowing from abroad, or running down foreign exchange reserves;

(v) accumulation of arrears.

Date: 2015-02-28; view: 856