High Budget Deficits and the Growth of the Economy in the Future - Term Paper Example

High Budget Deficits and the Growth of the Economy in the Future My hypothesis is that high budget deficits of today will eventually reduce the growth of the economy in the long term. Budget deficit is defined as the point where government revenue is less than government spending. Economic growth is defined as an increase in a countries productive capacity as measured by Gross Domestic Products usually referred to as GDP1. Whether a budget deficit is good or bad all depends on the economy that we are in and whether it suits the economic cycle. High budget deficits are usually needed when the economy needs a boost or it may have been in a recession. In my opinion this is a vital move as a recession can damage an economy if it last for several quarters. 2 Firstly due to the budget deficit government spending will increase. Government spending is a component of aggregate demand. Aggregate demand is defined as the total demand for all goods and services within the economy.3 It consists of Consumer spending, investment, government spending and exports and imports. Therefore when demand aggregate increases as shown in the diagram, the price rises from r0 to r1. Therefore in the short run we will be internationally uncompetitive in regards to prices. Therefore other countries will benefit and take our buyers. In addition to this we will become more dependent on other countries for certain goods and services.4 This is because when we become uncompetitive on a certain good or service, we will eventually stop making it. Consequently we will worsen our current account by increasing our imports. Imports are defined as goods and services that are made outside the country while exports are sold outside our country from us. As a result our economy will not grow to as much as it can as it will lose a large amount of its export market. However the multiplier should be taken into consideration as it will affect the magnitude of the increase in aggregate demand. Overall this is known as demand pull inflation. Increasing government spending may cause a budget deficit but it also has some benefits. For example the government may choose to create jobs in certain areas. Therefore these people may no longer be relying on the government for money. This seems to reduce government spending in the form of benefits. As a result that type of money can be put to better use such as children’s education or investments. Furthermore jobs are created so people have more consumer spending. Consumer spending is defined as the amount of spending spent by each household. Consumer spending is the largest portion of aggregate demand. Also if taxes are lowered then people have more money to spend. When people spend money the shops make profit. Profit can either be given to shareholders or it can be invested. Now in the short run prices will rise. However if firms invest carefully and on the right things, then prices can be reduced. Firms can spend money on new machinery or training programmes for workers.5 By doing this it will reduce their production costs and lowers the prices of goods and services. As a result we will be more internationally competitive and will be able to export a lot more goods and services. As the diagram shows that investment shifts the aggregate supply curve to the right, causes the prices levels to fall from Pt to Po. In addition output increases. High Budget deficits entail the characteristics of the fiscal policy. High government spending and lowering taxes causes budget deficits. One factor which agrees with my hypothesis is that in the short term high budget deficits will make us internationally uncompetitive when it comes to prices and this could lead to future repercussions.6 Both monetary and fiscal policies both affect whether we have a budget deficit or a surplus. Fiscal policy has been discussed previously with regard to government spending and taxation levels. Monetary policies do have an affect on the government’s budget; however they affect it less than fiscal policies. Monetary policies consist of the interest rate and the supply of money. If the money supply is increased or interest rates are lowered then this stimulates more money into the economy. If the interest rates are lower it is much more favourable to borrow money. In addition mortgage repayments are much easier to handle. Therefore consumers have more disposable income. This is income after taxes including benefits. Consequently they spend more money in shops resulting in the shops making more profit. If the firms decide to invest the profit in new stores, this provides job. If people have jobs they do not reply on the state for money and this causes the government spending to decrease.7 In addition the government will receive more revenue as they worker has to pay tax. This helps the government in its quest for budget surplus, were taxation exceeds government spending. Also if interest rates are decreased firms themselves can directly borrow money from the banks at favourable rates and begin to invest the money and provide more jobs. On the other hand if the money supply is decreased and interest rates are increased this results in borrowing to be much harder as the repayments are a lot steeper. Also mortgage repayments become too much, and disposable income begins to decrease. This means the public are less likely to go and send money. This causes shops to lose money and make less profit. If this type of scenario occurs for a long period of time, some business may be forced to close down. Therefore a lot of people will lose their jobs. Thy will then claim benefits and increase government spending but they will no longer be paying tax. As a result the government will have to try and stimulated the economy by spending money to try and provide jobs. This causes the budget deficit to worsen.8 Many people argue do we really need to have a high budget deficit. In my own opinion without the increased government spending, especially in times of recession the companies would not be able to make substantial profit. Also without the profit they would not be able to invest money for the future, for example on training programmes to make workers more efficient. Investment is vital for future economic growth. However it all depends on the companies owners. Usually the owners will either keep all the profits without investing. Sometimes the owners may reduce the production costs by investing in new machinery. But they will not lower the prices and will gain more profits. Therefore we do not feel the benefit of becoming more internationally competitive and will not be able to make our economy grow at the expected rate. A high budget deficit can and should not be sustained for a great period of time. In my personal view it should just be used to get the economy back up and running. Otherwise it will cause damage to our economy as the debt will just increase vastly. The USA has a lot of debt mainly due to wars that they have been involved in and if they continue to run a high budget deficit then they will increase their debt. However they are finding it difficult at the moment because the debt that they have built up also includes yearly interest. So they are having to pay of parts of the debt and the interest which is accumulating. Studies have shown that at least two million Americans will file for bankruptcy this year. It is common culture in America that people outspend themselves. Much of this is due to credit cards which provide easy purchase of goods and services. On average Americans spend 15% of their disposable income on repayments to debts every year. Also each household on average owed over eight thousand dollars in debt. In addition due to the debt a lot of people lost their jobs. Furthermore, those who were fortunate not to lose their jobs had to take a significant pay cut either through lower wages or reducing working hours. Also due to the debt, only low paid jobs can be created as the higher paid jobs require more investment which is not available.9 Overall I conclude that my hypothesis that high budget deficits today will eventually reduce the growth of the economy in the long term is partially. This is due to the fact that it depends on what the extra government spending is spent on and if companies invest to lower prices for customers. If this does happen then my hypothesis would be incorrect as the USA would be exporting goods and services all around the world as their prices would be cheaper than most other countries. However if the lowering of taxes or increasing of government spending is not used correctly then economic growth in the future will not grow as quick because aggregate demand will shift to the right in the short term increasing the prices. This would make the USA less price competitive and would eventually cause us to import more goods and services worsening our current account. However the hypothesis is generally correct as long term high budget deficits are not good and will prevent the growth of the economy because debts will begin to pile up. Budget deficits should only be used for a short while just to stimulate the economy if it’s in recession for example. Eventually the debts will have to be paid off and this means taking money from the economy. This can only harm the growth of the economy in the future. Work Cited Case: K.E., Fair, R.C., and Oster, S.E. (2009) Karl E. Case, Ray C. Fair, Sharon M. Oster, 2008. Principles of Macroeconomics, pgs 18-78, 156-201 Lambert M Surhone, Mariam T Tennoe, Susan F Henssonow, 2001. Upper Saddle River, pgs 46-78 Lambert M Surhone, Mariam T Tennoe, Susan F Henssonow, 2001. Upper Saddle River, pgs 46-78 http://www.bized.co.uk/sites/bized/files/images/d_pull.gif Image showing Aggregate demand shifting to the right http://content.answcdn.com/main/content/img/investopedia/supplyshock.gif Image showing Aggregate supply shifting to the right Read More