Public sector borrowing requirement (psbr), Managerial Economics

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Public Sector Borrowing Requirement (PSBR) is the amount which the government needs to borrow in any one year to finance an excess expenditure over income.

Effects of Government Borrowing on the Economy

If the government borrows from the general public, this may divert funds from more productive uses.

Firms also require finance and it may be that individuals and financial institutions prefer to lend to the government where the risk is less and possibly the returns are greater.  Thus the public sector may "crowd out" the private sector.   This is known as the "crowding out" effect.

A further harmful effect may occur.  Government borrowing will tend to raise the rate of interest.  This increase in interest rates will make certain capital investments less profitable resulting in a fall in investment, slower economic growth and a reduction in the competitiveness of he industries.

The increase in interest rates will also raise the cost of borrowing money for the purchase of houses and other goods hence an increase in the cost of living leading to inflationary wage pressure.

To avoid the above adverse effects, the government would borrow from the banking system the use of Treasury Bills; But this would raise eligible reserve assets in the banking system and thereby the money supply and the resultant inflation:  This puts the government in a dilemma.

The above pattern could be alleviated if the size of the PSBR was reduced.  This could be done by:

Reducing government expenditures and/or increasing taxation:  The first option is the trend in recent years but increased taxation is said to have the effect of reducing initiative and incentives.

Of late, employment has been put in the control of PSBR and ensuring that the growth of money did not exceed the growth of output.

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