Problems of Budget Deficits
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A budget deficit occurs when Government spending is greater than tax
revenues. For political reasons a budget deficit often occurs. Politicians never
gain votes by raising taxes and cutting spending. With many major World
economies facing a large budget deficit. It is worth considering the main
economic disadvantages of Government borrowing.
The govt will have to borrow from the private sector, in the UK the
government does this by asking the Bank of England to sell bonds and gilts to
the private sector.
Higher debt interest payments
Selling bonds will increase the national debt, this is currently £300
billion. The annual interest payments is approximately £23 billion, this has a
high opportunity cost because it requires future generations to pay higher
A budget deficit implies lower taxes and increased G, this will increase AD
and this may cause higher Real GDP and inflation.
Higher Taxes and lower spending
In the future the govt may have to increase taxes or cut spending in order to
reduce the deficit. This may cause reduced incentives to work
Increased Interest rates
If the govt sells more bonds this is likely to cause interest rates to
increase. This is because they will need to increase interest rates in order to
attract investors to buy the extra debt. If govt interest rates increase this
will push up other interest rates as well.
Increased govt borrowing may cause a decrease in the size of the private
sector (see fiscal policy)
In extreme circumstances the govt may increase the money supply to pay the
debt, however this is unlikely to occur in the UK
If the govt sells short term gilts to the banking sector then there wil be an
increase in the money supply, this is because banks see gilts as near money
therefore they can maintain there lending to customers. However they will also
be increasing the money supply by lending to the govt.
note the effect of a budget deficit depends to some extent on the cause. For
example in a recession a budget deficit may be necessary to get the economy out
of recession. If the government is borrowing to invest in infrastructure and
education this can benefit the economy in the long term.
About the Author
Richard Pettinger studied Politics and Economics at Lady Margaret Hall,
Oxford University. He now works as an economics teacher in Oxford. He enjoys
writing essays on Economic and he edits an Economics Blog focused on UK and US
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Article Published/Sorted/Amended on Scopulus 2007-03-17 00:04:23 in Economic Articles