1. Source: Troy Davig and Michael Redmond “Accounting for Changes in the U.S. Budget Deficit”. Economic Review (01612387). 2014 4th Quarter, p5-27. 23p.
a. Temporary factors affecting the deficit
i. Short term policies aimed at battling inflation or boosting up the economy at times of recession, very needed at the moment of enactment but should die away when the need no longer exist to help balance the budget
b. Automatic stabilizers
i. As name implies automatic stabilizers acts without any change in policy or legislation. They act to either increase budget deficit or surplus depending on the situation. They make fluctuations in federal budget more pronounced but are necessary for smooth functioning of economy overall.
c. Structural deficit
i. Arises in absence of automatic stabilizes or changes in legislations. In general it is propensity of government to either spend more than it takes in or spend less than its revenues.
d. In general article lists out deficit accounting without delving into deficit consequences.
2. Source: Barack Obama Address Delivered to a Joint Session of Congress, U.S. Capitol Building, Washington D.C. Jan. 20, 2015
a. Cutting deficits during expansionary periods
i. Mr President talks about policies which increased the deficit like increased benefits, increased public spending, but states that they were essential in bringing about economic growth and tells that keeping a balanced budget is essential while emphasizes the need for public spending on education and other areas which bring about long term prosperity.
3. Source: Chris Edwards (2015) “The Need to Balance the Budget and Reduce Federal Debt” www.cato.org
a. Before the Great Depression policy makers believed in balanced budget but those views were changed after widespread popularity and possibly inappropriate understanding of Keynesian theory
b. Budget deficit imposes burden on future generations by hindering capital formation and increasing future taxes which can potentially decrease labor market participation and hinder businesses from being opened
c. In early days of United States as a country debt was seen as immoral and contradicting to true liberty and independence
d. 1835 – 1837 only period in the history of US that country has been debt free
e. Government balanced its budget every year from 1866 to 1893
f. Deficit spending can be dated to 1930 with two main factors: great depression and Keynesianism
g. In period from 1791 to 1929 government balanced its budget in 68% of years while in period from 1930 to 2015 in only 15% of years
h. Two ways a subsidy policy might damage the economy
i. Spending distortions always happen as a result of subsidies, allowing some to work less while subsidized businesses tend to overproduce or overspend
ii. Since taxes are proportional debt may induce people to stray away from their “optimal” behavior resulting in deadweight loss
i. There are also other effects of spending financed by borrowing rather than current taxes
i. No strict balanced budget program or agenda may induce policy makers to spend on low value programs as spending and lowering taxes is always more favorable to policy makers
ii. Liability to pay the debt lies on future generations which has lots of negative consequences as reduced labor market participation, decreased investment etc. Debt can be lowered by inflation but inflation is also a tax on consumer’s real income
iii. Due to capital markets US can borrow from abroad but such policy might in theory crowd out exports by increasing the value of currency. Also translates burden of paying dividends on to future generations
iv. High debt to GDP ratio creates economic instability and fragility in global markets when debtor is such huge player as US
j. The vast majority of debt is not spend on capital investment but rather in current consumption and subsidy programs
4. Source: L.C. Risti, C. Nicolaescu, D. Tagaduan (2013) “Budget Deficits Effects on Economics Growth” Journal of Economics and Business Research
a. Results by Kneller, Bleaney and Gemmel (1999) differentiate between different sources of budget deficit and its effect on economic growth
i. Budget deficit as a result of a reduction of distortionary taxation has positive effect on economic growth (reduction in deadweight loss)
ii. Budget deficit as a result of reduction of non-distortionary taxation has no effect on economic growth
iii. Budget deficit resulting from increase of public spending on productive areas (capital investments) has positive effect on economic growth
iv. Budget deficit resulting from increase of public spending on non-productive areas either has no effect or negative effect on economic growth
b. Budget deficit according to Fisher (1993) has negative correlation with capital accumulation and productivity growth
c. Empirical evidence suggests that budget deficit above 3% of GDP has negative effect on growth while budget deficit around 1.5% has no or positive effect on growth
d. Econometric model by authors predict that a 1% reduction in budget deficit will lead to 0.97% increase in rate of growth of GDP
i. Though R2 is very low because the econometric model is extremely simple having only one dependent variable, so a lot of factors are not accounted for
5. Source: M Solomon and W A de Wet (2004) “The Effect of a Budget Deficit on Inflation: The Case of Tanzania” Sajems ns Vol 7
a. Discusses AS-AD model relationship between budget deficit and inflation
i. Budget deficit and especially the one financed by printing money causes short term increase in output, resulting increase in wages, however sooner or later prices catch up to artificial increase in output resulting in decrease of real balances and return of output to pre stimulus levels but with higher prices
b. According to monetarism and Milton Friedman’s famous theory of money - inflation is always and everywhere a monetary phenomenon
i. Budget deficit per se does not cause inflation, but rather budget deficit sponsored by printing press
ii. Empirical evidence is inconclusive as it is hard to filter out the effect of money supply increase on inflation and the effect of budget deficits
c. Vicious cycle of budget deficit and inflation
i. Budget deficit creates inflation and because payments to government happen with a lag, during periods of high inflation real tax receipts may be significantly lower than those imposed, which lowers the revenue and further increases budget deficits, which in turn further increases inflation an so on
d. Developing countries highly dependent on weather related agricultural industry are extremely susceptible as any change might trigger shortage of supply, thus requiring fiscal stimulus. If the country already runs budget deficit such situation might quickly turn out bad for the economy.