CDS (I) 2022 General Knowledge · Question 37 of 120

Correct — C, John Maynard Keynes. Deficit financing means a government deliberately spending more than it raises, and treating the gap as a policy instrument rather than an embarrassment. That idea is credited to Keynes, who argued in the wake of the Great Depression that when private demand collapses, output and employment settle at a low level and stay there unless something outside the market injects spending. His General Theory of Employment, Interest and Money, published in 1936, made the case that public expenditure financed by borrowing raises effective demand and, through the multiplier, pulls income up by more than the original outlay. Before Keynes the orthodoxy ran the other way: a balanced budget was a virtue in itself.

• (a)Adam Smith — Adam Smith stands at the head of the fiscal-conservative tradition that Keynes was arguing against. The Wealth of Nations of 1776 treats government borrowing as a drain on the capital available to industry, and a balanced budget as the proper rule.
• (b)Alfred Marshall — Alfred Marshall was the great systematiser of neoclassical microeconomics — demand and supply curves, elasticity, consumer surplus, the short and long period. He worked on the economics of the individual market, not on managing aggregate demand through the budget. Keynes was his student.
• (d)Milton Friedman — Milton Friedman came a generation after Keynes and led the counter-attack. His monetarism held that steady growth of the money supply, not discretionary deficit spending, is what stabilises an economy, and he doubted that fiscal fine-tuning works at all.

Deficit financing is the practice of meeting a shortfall between government expenditure and revenue by borrowing, or in its older Indian sense by borrowing from the central bank so that new money is created. Keynesian theory treats it as counter-cyclical: run a deficit in a slump to raise demand, and unwind it in a boom. India adopted the tool from the Second Five Year Plan onwards to fund developmental outlay beyond what taxes could raise, and the practice of automatic monetisation through ad hoc treasury bills was ended in the 1990s.

All four names are famous, so the question is really about which century and which branch of the subject each belongs to. Smith and Marshall are pre-Keynesian and both work outward from individual markets; Friedman is post-Keynesian and hostile to the idea. Only Keynes wrote in the specific circumstance — mass unemployment in the 1930s that markets were not clearing — that made deliberate deficits look like a remedy rather than a failure. One honest qualification: economists elsewhere, notably in Sweden and in Poland, reached comparable conclusions at about the same time, and governments had run deficits for centuries without theorising them. What is credited to Keynes is the identification of the deficit as a deliberate instrument of employment policy, and that is what the stem's phrase first mooted the idea is reaching for.

• Keynes published The General Theory of Employment, Interest and Money in 1936, in the aftermath of the Great Depression.
• Government deficit spending was first identified as a necessary economic tool by Keynes; fiscal conservatism, traceable to Adam Smith, had been the dominant position until the Depression.
• The Keynesian case rests on effective demand and the multiplier — an initial injection of public spending raises national income by a larger amount.
• Milton Friedman's monetarism argued that control of the money supply, not discretionary fiscal deficits, is the effective stabiliser.
• In India deficit financing was used from the Second Five Year Plan to raise resources for development spending.

• Treating deficit financing as identical to fiscal deficit — the first is a method of financing, the second a measured gap.
• Assuming Marshall, as Keynes's teacher, must share his macroeconomic positions.
• Reading Friedman as a Keynesian because both wrote on government policy — he argued the opposite case.

As an attribution question naming four economists, or as a definitional item asking what deficit financing is used for in India.

• practice — not a real PYQ

  The General Theory of Employment, Interest and Money was published in which year?

  • (a)1776
  • (b)1890
  • (c)1936
  • (d)1962

  Answer(c) 1936 — Keynes wrote it in the aftermath of the Great Depression; 1776 is the year of Adam Smith's Wealth of Nations.

• practice — not a real PYQ

  The increase in national income brought about by an initial increase in investment, being larger than that initial increase, is described by which concept?

  • (a)The accelerator
  • (b)The multiplier
  • (c)Crowding out
  • (d)The liquidity trap

  Answer(b) The multiplier — successive rounds of induced consumption spending make the final rise in income a multiple of the original injection.