Rising Budget Deficits and National Debt

• Budget deficit


  Government spending is greater than tax revenue in a year, resulting in government borrowing
• Structural budget deficit


  A budget deficit when the economy is at full employment, indicating that the government is not earning enough tax revenue to cover its spending
• Cyclical budget deficit


  A budget deficit in a recession, where government spending on benefits rises and tax revenues decrease
• National debt


  The total stock of government debt over time, a stock concept compared to budget deficits which are flow concepts
• At the end of the year

  The budget deficit goes back to zero and the debt gets added to the national debt
• Expansionary fiscal policy


  Government increasing spending or reducing taxation to stimulate the economy
• Higher aggregate demand, growth, and lower unemployment are major pros of expansionary fiscal policies
• Keynesian economists argue that a budget deficit in a recession is a worthwhile policy to get the economy out of recession
• Higher government spending on education, healthcare, infrastructure, and public services can lead to long-run benefits by increasing the productive capacity of the economy
• Government policies can solve market failures, improve resource allocation, boost living standards, and reduce income inequality
• Tax cuts, especially direct tax cuts, can provide incentives for work, productivity, entrepreneurship, and immigration, leading to higher productivity and greater tax revenue returns
• LRAS could boost long-term growth rates
• Link to higher productivity from incentives

  Greater tax revenue returns from greater activity
• High productive incentives can lead to greater tax revenue returns
• Keynesian economists argue that more government spending, even if it's debt-fueled, can crowd in the private sector and promote more private sector investment
• Keynesian argument


  Government spending increases aggregate demand in the economy, which increases output and activity, promoting private sector firms to invest and grow their business
• Keynesian argument keeps growth going in both the short run and the long run and can balance economic growth
• Significant concerns about government finances include budget deficits going up significantly, national debt figures rising, and operating outside fiscal rules
• Lower confidence in the state of government finances can lead to lower credit ratings on government bonds
• Lower credit ratings mean higher coupon rates on government bonds, making it harder and more expensive for governments to borrow money over time
• Debt will have to be paid back, leading to negative implications such as tax rises or cuts to government spending
• Unproductive spending due to rising government debt has long-term implications on the economy and living standards
• Burdens on future generations due to rising government debt include tax rises, cuts to government spending, and higher debt interest payments
• Flexibility of government spending in the future can be constrained if government finances are in a bad way
• Lower confidence in government finances can detract foreign direct investment, harming short-run and long-term growth
• Expansionary fiscal policies can lead to conflicts with macro objectives like demand-pull inflation and worsening current account deficits
• Debt-fueled government spending could crowd out the private sector and harm private sector investment
• Increased demand for loanable funds in the loanable funds market can increase equilibrium interest rates, making it more expensive for private sector firms to borrow
• Government spending


  Crowd out the private sector and harm private sector investment
• Increased demand for loanable funds in the loanable funds market

  Increases equilibrium interest rates, making it more expensive for private sector firms to borrow and fund investment projects
• Harming private sector investment

  Bad news for short run and long run growth
• Constraining private sector investment too much reliance on the public sector


  Unbalanced growth
• Concerns about inefficiency and wastefulness in government spending

  Governments not profit-motivated and not experts in various infrastructure projects
• Current state of government finances

  If already in a bad way, high budget deficits, high national debt, operating outside fiscal rules, cons likely outweigh pros. If good, sustainable with low deficits and debts, pros could outweigh cons
• Short run and long run impacts of policies


  Long run returns could outweigh short run issues
• Stage of the economic cycle

  In a recession, running a budget deficit is desirable to increase aggregate demand and return the economy to full employment. In a boom, policies may be inflationary and unnecessary
• Role of consumer and business confidence in policy effectiveness

  Strong confidence is crucial for the effectiveness of direct tax cuts
• Role of automatic stabilizers


  Can naturally support economic growth and output in a recession, reducing the need for discretionary fiscal policy