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Deficits and financial change in the Pacific Basin

  • Design
  • Economics
  • Political Science


FRBSF January 4,1985 WEEKLY LETTER Deficits and Financial Change in the Pacific Basin Government budget positions in most Pacific Basin nations deteriorated sharply in the aftermath of the worldwide economic slump of the rnid- 1970s. Budget deficits in the market-oriented economies of the region have since averaged rough Iy 4 percent of thei r respective GNPs. Finan- cing shortfalls ofthis magnitude has not proven an easy task, and, at various times, has been respon- sible for inflation, disintermediation, and compet- itive shifts among financial institutions. This Letter explains how the need to finance large deficits oftentimes has produced the problems mentioned,and argues that the responses of the market and financial regulatory authorities have constituted an important, although frequently in- advertent, impetus to financial innovation and li- beralization in a number of Pacific Basin nations. Financing options Governments have a number of options in finan- cing budget deficits. At the most fundamental lev- el, fiscal authorities must choose between borrow- ing abroad (i.e., from foreign investors, foreign banks, or international agencies) and borrowing from domestic sources. Foreign loans represent a majorfunding source for a number of Pacific Basin nations. Indonesia, for example, finances virtually all of its budget deficits abroad. But this Letter will concentrate on domestic financing and its relation to financial innovation. When a government chooses to finance deficits domestically, i.t has several options: it can sell its debtto the central bank ("monetize" the deficit), it can persuade or require financial institutions to absorb government debt (turning the institutions into "captive" sources offunds), or itcan design a "market oriented" approach to selling govern- ment debt instruments. Monetary finance Useofthecentral bankto finance deficits involves increasing bank reserves, which in turn leads to increases in the stock of money. Ultimately, the private sector finances

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