According to Rose (2002), a budget deficit can be described as a situation that occurs when the government tends to spend more funds than the funds that are flowing into the economy. It can also be described as a situation where the government, private, public companies, and individuals’ total spending on particular goods or services actually is more than the income which they tend to generate or receive for a particular given time period (Rosen,2002). This, therefore, indicates that a government may opt to run a budget deficit purposefully for the sake of increasing the levels of economic activities as well as with an aim of increasing tax revenues.
According to the studies done by Jha (1998), on Keynesian theories running a fiscal deficit will increase the level of government debt and this will create an environment where the economic activities of a given country’s output increases and this increase in the economic activities in the economy will lead to an increase in total country’s gross domestic product The increase in the levels of economic activities normally leads to a situation where high revenues are collected inform of taxes (Brown &Jackson, 1986).
The government may opt to run a budget deficit during the periods of severe recessions or depression which is a period when the rates of unemployment are high, there are low levels of investments and the total level of production is low which greatly affects the profits that tend to be received by particular companies (Kaul & Conceicao, 2003). To deal with this situation the government may decide to borrow more funds or to run a budget deficit in order for the government to effectively deal with this period. According to studies done by Rosen (2002), the Keynesian theory of unemployment shows that a government running a deficit budget will help end or moderate recession. During the periods government may increase its spending or purchases this, in turn, leads to the creation of more markets for new businesses. When more markets are created in an economy it increases opportunities for more employment which in the end increases the total levels of income in the economy (Rosen, 2002). In addition, this tends to create more opportunities in the economy causing an increase in the level of consumer spending as an increase in the level of income has a positive effect on the levels of consumption. An increase in the level of consumption leads to an increase in demand for any given business output. This multiplier effect leads to an increase in the real gross domestic product which eventually lowers the rate of unemployment (Rosen, 2003).
Furthermore, the government may opt to use or run deficits in order for the government to increase in the size of the market which in the end leads to stimulation of the economy hence acting as an incentive to private investors who uses the opportunity to increase investment in the economy raising the levels of employment as well as increasing the levels of demand for products and services. According to Brown and Jackson (1986), if private investment in an economy increases it acts as stimulation for any economy to increase its output levels in the long run. This increase provides more funds through which the government is able to spend more on infrastructure, public health, education and other social activities which potentially increase the level of growth in the economy (Brown & Jackson, 1986).
In addition, studies by Rosen (2002), shows that when a given economy uses the flexible exchange system then the increase in the level of budget deficits causes a situation where the interest rates in an economy will tend to move upwards. When this situation occurs in the economy it causes increases in the levels of capital inflows to the economy which in turn leads to the appreciation of the nation’s currency hence reducing the level of net exports but an increase in the level of imports which results in the crowding out of the net foreign investment and the increase of domestic investment (Jha, 1998).
The use of budget deficit by the government has serious consequences on the economy. Firstly, it leads to inflation since due to the situation the government may opt to increase its money supply through more printing of its currency in order to curb the deficit situation. This may lead to high levels of money supply in the economy which in the end leads to the increase in the prices of goods and services as well as the devaluation of a given currency (Kaul & Conceicao, 2003).
The government deficit budget also is believed to have a major effect on a given government’s economy through the loanable funds’ markets. This normally occurs in a situation where there is not enough money which is collected in form of tax revenues to cover all the government spending then it implies that the government looks for an alternative way which is to borrow (Rosen,2002). When the government borrows funds from outside it causes the demand for the loanable funds to increase. This creates a situation where the interests rates tend to move upwards. The increases in the interest’s rates cause an overcrowding effect and normally this has a negative effect on private investment spending since many investors would increase their investment in any economy if the interest rates are low (Rosen, 2002). The upward increases in the level of interest rates increases demand a situation that tends to cancel the presence of a deficit in the economy which eventually causes a long-term effect on the long-term supply side of the economy (Kaul &Conceicao, 2003).
A government deficit also is believed to have a major effect on the level of interest debt payments. Government deficit causes higher interest debt payments since by the government selling bonds in order to pay the national debt this normally leads to higher costs and higher payments costs because this situation tends to restrict the government’s ability to raise any funds from other sources which can be used to cut down its outlays (Jha, 1998).
The other economic effect of a government running a deficit is that it causes a situation where the government tends to increase its borrowings for it to effectively finance its public spending. When this occurs the government will tend to rely so much on the private sector for its financing a situation that has a negative effect on the public sector. Furthermore, the use of a budget deficit means the revenue from the taxes is low but an increase in the level of government spending causes an increase in the level of aggregate demand which in the end leads to a higher level of Real Gross Domestic Product as well as inflation (Brown& Jackson, 1986). Moreover, in some situation where is high levels of fiscal deficit the government may opt to increase its taxes so as to cut down its spending or to reduce the budget deficit, this may act as a reduced incentive for investment as well as for work (Rosen,2002).
Lastly, a budget running a deficit by the government leads to increases in the rate of interest rates since the government selling more of its bonds will cause an increase in the rate of interest rates. Normally the government will opt to increase the interest rates for it to be able to attract more investors this also will have a negative effect on the other interest rates of the economy (Rosen, 2002).
References
- Harvey S. Rosen (2002), Public finance; Published by McGraw-Hill, 6th edition: ISBN 0072374055, 9780072374056
- C. V. Brown, P. M. Jackson (1986), Public Sector Economics; Published by McGraw-Hill, 3rd Edition: ISBN 0631145877, 9780631145875
- Raghbendra Jha (1998), Modern public economics; Published by Taylor & Francis:ISBN 0415143152, 9780415143158
- L. Kaul & P Conceicao (2003), The New Public Finance, Oxford University Press for the United National Development Programme.