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The government increases the deficit and debt when implementing expansionary fiscal policy. The increase in debt has two other effects, namely higher interest expenses and difficulties in repaying. Therefore, we can say the current outstanding government debt is the accumulated deficit from previous years. If the deficit continues every year, the debt will increase.
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So, the more sensible option is through debt. Hyperinflation endangers economic stability. However, it is an unwelcome option because it can lead to hyperinflation, causing the domestic currency’s purchasing power to fall. The main consequence of the deficit is debt. The government must borrow money to finance the deficit, mainly through the issuance of debt securities. Likewise, during natural disasters, government spending tends to swell. Therefore, the government usually adopts a budget deficit and takes out loans to finance such programs.įourth, deficits also arise when unplanned events occur. For example, during the war, the government spends more on the defense budget. Infrastructure often requires significant funding, more than can be financed through taxes. Third, the government runs a deficit to support long-term programs to increase the economy’s productive capacity. The most common examples are infrastructure development, physical (such as roads and bridges) and non-physical (such as education and training). Also, spending such as unemployment benefits decreases due to lower unemployment rates. Business profits and household income improved. An example is social spending, such as unemployment benefits.įurthermore, the budget deficit decreases when the economy is prosperous (economic expansion). On the other hand, the expenditure of some posts will usually increase. That makes less tax the government can collect. Second, budget deficits can occur when the economy is sluggish, such as during a recession. During this period, business profits and household income fell. As consumption increases, it stimulates demand and encourages businesses to increase production. They have more money to spend on goods and services. For example, when lowering the income tax rate, individuals spend less to pay taxes. To carry out expansionary fiscal policy, the government can combine increased government spending and a decrease in taxes. Or, the government increases the deficit from the previous period. In this case, the government may move from a budget surplus to a budget deficit. There are several reasons why the government budget is a deficit.įirst, the government runs a deficit to stimulate short-term economic growth. A deficit is one way of stimulating aggregate demand and economic growth, as Keynesian economists suggest. Structural deficits arise because of government discretionary decisions and are permanent. In other words, it is unaffected by economic conditions. Meanwhile, structural deficits represent deficits that remain throughout the business cycle. The government collects more taxes due to improved business profit and household income prospects. These conditions are the opposite during a prosperous economy. On the other hand, the budget for social spending, such as unemployment benefits, increases with the high unemployment level. During a weak economy, tax revenues fall as the prospects for business profits and household income deteriorate. Government budget = Net taxes – Government purchasesĬyclical deficits occur due to the ups and downs of the business cycle.Since the primary source of revenue comes from taxes, some literature might write the above equation as: Government budget = Revenue – Expenditure.
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In general, we can formulate the government budget as follows: Unlike government spending, transfer payments do not involve the exchange of goods and services. Transfer payments consist of several programs, such as unemployment benefits and another social spending. Government spending includes routine expenditures (such as payment of employee salaries) and capital expenditures (such as infrastructure spending). The government’s money flows out in the form of expenditures on goods and services and transfer payments. It can be direct taxes such as income tax and indirect taxes such as value-added tax and excise. Tax revenue flows to the government from the private sector, namely households and companies. Since the primary source of government revenue is from taxes, some might define a deficit as government spending that exceeds tax revenue. We often refer to a government budget deficit as a fiscal deficit. A government deficit is when government spending exceeds revenue.