Budget Deficits and Debt: A Global Perspective
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Proponents of fiscal conservatism date back to Adam Smith , founder of modern economics. Fiscal conservatism was the dominant position until the Great Depression, associated with the gold standard and expressed in the now outdated Treasury View that government fiscal policy is ineffective. The usual argument against deficit spending, dating to Adam Smith, is that households should not run deficits—one should have money before one spends it, from prudence—and that what is correct for a household is correct for a nation and its government.
A similar argument is that deficit spending today will require increased taxation in the future, thus burdening future generations.
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See generational accounting for discussion. Others argue that because debt is both owed by and owed to private individuals, there is no net debt burden of government debt, just wealth transfer redistribution from those who owe debt government, backed by tax payers to those who hold debt holders of government bonds. A related line of argument, associated with the Austrian school of economics , is that government deficits are inflationary.
Anything other than mild or moderate inflation is generally accepted in economics to be a bad thing. In practice this is argued to be because governments pay off debts by printing money, increasing the money supply and creating inflation, and is taken further by some as an argument against fiat money and in favor of hard money , especially the gold standard. Some Post-Keynesian economists argue that deficit spending is necessary, either to create the money supply Chartalism or to satisfy demand for savings in excess of what can be satisfied by private investment.
Chartalists argue that deficit spending is logically necessary because, in their view, fiat money is created by deficit spending: fiat money cannot be collected in taxes before it is issued and spent ; the amount of fiat money in circulation is exactly the government debt —money spent but not collected in taxes.
In a quip, "fiat money governments are 'spend and tax', not ' tax and spend '"—deficit spending comes first. Chartalists argue that nations are fundamentally different from households. Governments in a fiat money system which only have debt in their own currency can issue other liabilities, their fiat money, to pay off their interest bearing bond debt. They cannot go bankrupt involuntarily because this fiat money is what is used in their economy to settle debts, while household liabilities are not so used.
This view is summarized as:. But it is hard to understand how the concept of "budget busting" applies to a government which, as a sovereign issuer of its own currency, can always create dollars to spend. There is, in other words, no budget to "bust". A national "budget" is merely an account of national spending priorities, and does not represent an external constraint in the manner of a household budget.
Continuing in this vein, Chartalists argue that a structural deficit is necessary for monetary expansion in an expanding economy: if the economy grows, the money supply should as well, which should be accomplished by government deficit spending. Private sector savings are equal to government sector deficits, to the penny. Chartalism is a small minority view in economics; while it has had advocates over the years, and influenced Keynes, who specifically credited it,  A notable proponent was Ukrainian-American economist Abba P.
Lerner , who founded the school of Neo-Chartalism , and advocated deficit spending in his theory of functional finance. Chartalists, like other Keynesians, accept the paradox of thrift , which argues that identifying behavior of individual households and the nation as a whole commits the fallacy of composition ; while the paradox of thrift and thus deficit spending for fiscal stimulus is widely accepted in economics, the Chartalist form is not.
An alternative argument for the necessity of deficits was given by U. When the outlay of a government i. Governments usually issue bonds to match their deficits. They can be bought by its Central Bank through open market operations. Otherwise the debt issuance can increase the level of i public debt, ii private sector net worth, iii debt service interest payments , and iv interest rates.
See Crowding out below. Deficit spending may, however, be consistent with public debt remaining stable as a proportion of GDP , depending on the level of GDP growth. The opposite of a budget deficit is a budget surplus ; in this case, tax revenues exceed government purchases and transfer payments. For the public sector to be in deficit implies that the private sector domestic and foreign is in surplus. An increase in public indebtedness must necessarily therefore correspond to an equal decrease in private sector net indebtedness.
In other words, deficit spending permits the private sector to accumulate net worth. On average, through the economic cycle, most governments have tended to run budget deficits, as can be seen from the large debt balances accumulated by governments across the world. Following John Maynard Keynes , many economists recommend deficit spending to moderate or end a recession , especially a severe one.
When the economy has high unemployment, an increase in government purchases creates a market for business output, creating income and encouraging increases in consumer spending , which creates further increases in the demand for business output. This is the multiplier effect. This raises the real gross domestic product GDP and the employment of labour, and if all else is constant, lowers the unemployment rate. The connection between demand for GDP and unemployment is called Okun's law. The increased size of the market, due to government deficits, can further stimulate the economy by raising business profitability and spurring optimism, which encourages private fixed investment in factories, machines, and the like to rise.
This accelerator effect stimulates demand further and encourages rising employment. Increase in government payroll has been shown to depress the economy in the long run. Similarly, running a government surplus or reducing its deficit reduces consumer and business spending and raises unemployment.
This can lower the inflation rate. Any use of the government deficit to steer the macro-economy is called fiscal policy. A deficit does not simply stimulate demand. If private investment is stimulated, that increases the ability of the economy to supply output in the long run. Also, if the government's deficit is spent on such things as infrastructure, basic research, public health, and education, that can also increase potential output in the long run.
Finally, the high demand that a government deficit provides may actually allow greater growth of potential supply, following Verdoorn's law. Deficit spending may create inflation , or encourage existing inflation to persist. For example, in the United States Vietnam-war era deficits encouraged inflation. This is especially true at low unemployment rates. But government deficits are not the only cause of inflation: It can arise due to such supply-side shocks as the oil crises of the s and inflation left over from the past e. If equilibrium is located on the classical range of the supply graph , an increase in government spending will lead to inflation without affecting unemployment.
There must also be enough money circulating in the system to allow inflation to persist, so that inflation depends on monetary policy. Many economists believe government deficits influence the economy through the loanable funds market , whose existence Chartalists and other Post-Keynesians dispute. Government borrowing in this market increases the demand for loanable funds and thus ignoring other changes pushes up interest rates. Rising interest rates can crowd out, or discourage, fixed private investment spending, canceling out some or even all of the demand stimulus arising from the deficit—and perhaps hurting long-term supply-side growth.
Increased deficits also raise the amount of total income received, which raises the amount of saving done by individuals and corporations and thus the supply of loanable funds, lowering interest rates. Despite a government debt that exceeded GDP in , the U. The growth of the supply side , it seems, was not hurt by the large deficits and debts. A government deficit increases government debt. In many countries the government borrows by selling bonds rather than borrowing from banks.
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The most important burden of this debt is the interest that must be paid to bond-holders, which restricts a government's ability to raise its outlays or cut taxes to attain other goals. Usually when economists use the term "crowding out" they are referring to the government spending using up financial and other resources that would otherwise be used by private enterprise. However, some commentators use "crowding out" to refer to government providing a service or good that would otherwise be a business opportunity for private industry. National government deficits may be intentional, a result of policy decisions, or unintentional.
When an economy goes into a recession, deficits usually rise in the more affluent countries. Revenue from progressive taxes based on economic activity income, expenditure, or transactions falls. Other sources of tax revenue such as wealth taxes , notably property taxes , are not subject to recessions, though they are subject to asset price bubbles. Transfer payments due to increased unemployment and reduced household income rise.follow link
The Global Economy, Growth and Reducing Budget Deficits - IMF F&D Magazine
Most economists favor the use of automatic stabilization over active or discretionary use of deficits to fight mild recessions or surpluses to combat inflation. Active policy-making takes too long for politicians to institute and too long to affect the economy. Often, the medicine ends up affecting the economy only after its disease has been cured, leaving the economy with side-effects such as inflation. For example, President John F. Kennedy proposed tax cuts in response to the high unemployment of , but these were instituted only in and impacted the economy only in or and the increased debt encouraged inflation, reinforcing the effect of Vietnam war deficit spending.
Structural and cyclical deficits are two components of deficit spending. These terms are especially applied to public sector spending which contributes to the budget balance of the overall economy of a country. A cyclical temporary deficit is a deficit that is related to the business or economic cycle.
The business cycle is the period of time it takes for an economy to move from expansion to contraction , until it begins to expand again. This cycle can last anywhere from several months to many years, and does not follow a predictable pattern. The cyclical deficit is the deficit experienced at the low point of this cycle when there are lower levels of business activity and higher levels of unemployment.