High Budget Deficit and the Growth Rate of the Economy - Essay Example

? High Budget Deficit and the Growth Rate of the Economy Introduction In it was the third straight year when the gap between government's income and spending remained negative to the tune of $1 trillion or above. In percentage terms, the deficit is hovering at around 10 percent of Gross domestic product in last two years. It should be noted that budget deficit as percentage to GDP is steadily rising. This is causing serious concerns at several quarters on soaring national debt. Economists agree that huge deficits will reduce the economic growth in future years. The deficit financing is good during crisis times to bring the economy out from stagnation but harmful if it is employed in a sustained basis year after year for the unproductive causes. Nevertheless, the underlying causes for which deficit budget is made certainly matter. Budgetary Deficits in Last Decade In order to understand why there is so much concern about rising budgetary deficit, it will be appropriate to have a look on the US budget deficits in last one decade. In percent of GDP Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 (Estimated) Surplus or Deficit 1.3 -1.5 -3.4 -3.5 -2.6 -1.9 -1.2 -3.2 -10.0 -8.9 -10.9 Source: http://www.utahfoundation.org/img/pdfs/rr701.pdf Low National Saving Elwell (2010) emphasizes that national saving rate is important for future economic growth and budgetary deficit has a direct bearing on national saving rate. Since last many years private saving is meager in US and in last couple of years it has gone even negative. Saving as a nation gets further reduced by budget deficit because national saving is the private saving less budgetary deficit. The year wise savings rate in the last decade is tabulated as per the following. Saving Statistics of US (Figures as % of Gross Domestic Product) Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 Gross Public Saving 4.3 -0.9 - 1.8 -1.3 -0.1 1.0 0.5 -2.6 -6.4 Net Public Saving 0.2 -2.9 -3.7 -3.3 -2.0 -1.3 -1.5 -4.7 -8.7 Gross National Saving 16.5 14.7 13.9 14.5 15.1 19.1 14.5 12.6 10.6 Net National Saving 4.3 2.4 1.8 2.5 2.9 4.5 2.0 -0.2 -2.5 Source: http://www.fas.org/sgp/crs/misc/RS21480.pdf With such a low/negative saving, it is difficult to obtain economic growth and US productivity at desired rate. The nation with high private saving will offset the moderate deficit financing in a much better way to provide for investment capital necessary for the growth of economy. Thus, for future economic growth national savings matter highly. National saving is the measure of the accumulation of financial and other real assets overtime. Future national income will largely depend upon this accumulated stock of assets. Unfortunately, deficit financing coupled with nil or negative private saving has made the national saving negative. In this perspective, deficit financing on a sustained basis cannot help US economy. Higher Interest Rates Macguineas (2011) argues that ever increasing deficit financing will exert upward pressure on interest rates thereby increasing the cost of capital. Budgetary deficits are financed through government borrowings. When government borrowings rise to a high level, the government may have to offer increased interest rates so that sufficient buyers are attracted to buy government debt. Obviously, higher interest rates will tend to retard the economic growth rate. Higher Borrowing Leads to Higher Interest Payments Increasing borrowings year after year will necessitate higher spending on debt-interest. Higher interest burden eats away the productive deployment of the capital necessary for the economic growth. As a result, the needy sectors such as education, health starve of the funds that are necessary to provide impetus to the economy. Defense Spending and Budgetary Deficit Korb et al. (2011) of the center for American Progress (CAP) argue that defense spending has created the current fiscal crisis. The experts from the CAP believe that the massive deficit is the result of increasing defense budget during 2004 through 2012. It certainly matters if defense spending is the cause of deficit budget which does not result into increasing the productive efficiencies of the masses or any skill enhancement in general. The following graphics show how the defense budget increased during Iraq and Afghanistan war forcing the government to finance it through deficit financing. Source: http://economistsview.typepad.com/economistsview/2011/07/cuts-in-military-spending-to-reduce-the-deficit.html Fiscal and Monetary Policy Fiscal policy is seen as a tool for demand management. Froyen (1998) argues that by increasing the spending, employment can be created and aggregate income of the people can be increased. Similarly, by cutting the direct and indirect taxation the residual income in the hands of people can be increased. The government needs to play with the fiscal tool depending upon which business cycle economy is passing through. The fiscal policy measures can help curb the excessive demand during boom period and at the same time it can provide impetus to the economy during recession. During recession, the government cannot raise taxes to garner more resources needed for the growth instead it resorts to the deficit budgeting so that economy could be brought out of recession by spending. So deficit budgeting is not always bad at all times. It certainly has its own merits and to be used prudently for managing the aggregate demand in the market. On the other hand, monetarist economists put forward the argument that any fiscal intervention will have only temporary effect on aggregate demand, jobs or output. According to Froyen (1998), Fiscal policy and monetary policy cannot be interchanged. When the economy is passing through recession, monetary policy may turn ineffective in increasing income and spending. That is where the government may need to resort to fiscal policy in stimulating demand of goods and services. Keynesian economists recommend using both monetary and fiscal policies to control inflation and influence employment as well as output. They believe that fiscal measures can influence demand directly. Keynesian policy measures are now widely adopted throughout the world. Monetary and fiscal policy both are made use of simultaneously to bring the economy on track and deficit financing is one of the fiscal measures being employed in most of the nations of the world. Reason of Deficit Budget Does Matter The Budget deficit is not always harmful if it is intended to increase the economic output in the long run. The defense spending cannot be compared to the spending on education or job-training programs that enhance skill of masses to provide for the multiplier effect in the economy. Froyen (1998) stresses that if the budget deficit is due to tax-cut or lower taxes it still has the propensity to increase the economic output. Lower taxes will increase the disposable incomes in the hands of masses triggering demands of the goods and services. Higher demand of goods or services will push up the economic output of the nation. The higher disposable income could also result into the net savings and if that happens than that may push the economy to grow in subsequent years by capital investment within the country. Conclusion Thus, it can be concluded that when the government incurs debt, it is important to know what government does with that money. If the money is deployed for productive purposes – in skill enhancement of the masses or infrastructure buildup, it can certainly help the economy of the present as well as future generations. If deficit financing is simply to retire current debt or for the defense spending regardless of any real need or security threat to the country (examples are Iraq and Afghanistan war) then that will create holes for the future economic growth. The deficit financing is good during crisis times to bring the economy out from stagnation but harmful if it is employed in a sustained basis year after year for the unproductive causes. Reference 1. Cotti, M.L. (2011). Utah Foundation, U.S. Federal Deficits and Debt: Understanding the History and Context. Retrieved March 23, 2012 from, http://www.utahfoundation.org/img/pdfs/rr701.pdf 2. Elwell, C. (2010). Saving Rates in the United States: Calculation and Comparison. Retrieved March 23, 2012 from http://www.fas.org/sgp/crs/misc/RS21480.pdf 3. Froyen, R. (1998). Macroeconomics: Theories and Policies. 6th edition, Upper Saddle River, NJ: Prentice Hall. 4. Korb, J. L., Conley, L., & Rothman, A. (2011). What President Obama and Congress Can Learn About Defense Budgets from Past Presidents. Retrieved March 23, 2012 from http://www.americanprogress.org/issues/2011/07/defense_budgets.html 5. MacGuineas, M. (2011). Committee for a Responsible Federal Budget. Retrieved March 23, 2012 from http://articles.businessinsider.com/2011-05-06/politics/30032883_1_deficits-congressional-budget-office-interest-rates Read More