(Economic effects of Public or Government Debt):
Whenever national loans are increased, they can lead to economic instability in the country. In fact there is nothing good or bad with the debts; it all depends upon the wisdom of the administration.
If the government takes loans for the purposes of economic development and constructs dams, railways, canals, factories, roads, etc., then the productive capacity of the nation goes up and it leads to economic stability.
If debts are raised for consumption expenditure and the productive capacity of the nation is not increased, then they lead to economic instability in the country.
In order, to examine the economic effects of public debt, we will have to examine the following matter:
(i) The Amount of Loan. If the economy is functioning at the level of full employment, even a small amount of loan will create inflationary pressure in the economy. How much the price inflation will take place depends upon the amount of borrowing. The greater the borrowing, the heavier is the degree of inflation and vice versa.
(ii) Purpose of Loan. If the country is in the grip of depression and the loan is raised for productive purposes, it will increase income, output and employment in the economy. As the aggregate demand is increased with public debt, therefore, it has a healthy effect on the economy. If public loans are raised for fighting a war, it cripples the productive capacity of the nation and becomes a deadweight debt. These, therefore, result in the instability of the economy.
(iii) Internal Loan and External Loan. Public debt whether it is internal or external constitutes a burden on the commodity. The nature of burden of external debt, however, differs from the internal, debts. In case of external debt, the loan along with the rate of interest is to be paid to the creditor country. This means we deprive the citizens of our own country with the goods and services produced at home.
If the external loan is used for economic development, It will have a healthy effect on the economy. In case, it is used for consumption purposes or for waging a war, then they are burden on the community. It in fact is mortgaging of future.
The internal loans are raised from the central bank, commercial banks, and the people living in the country. If the internal debt is utilized for consumption expenditure, it will lead to inflationary pressure in the economy. If it is used for productive purposes (if excess capacity is not achieved), it will help in raising the level of income and employment and thus will lead to economic stability.
(iv) Rate of Interest. If a huge amount of public loan is incurred at a higher rate of interest, it will take away a sizable portion of the national income for its repayment. The economic stability of the country will, thus, be adversely affected.