Budget Deficit and Economic Growth



Budget Deficit and Economic Growth

Introduction

Budget deficit refers to a financial situation whereby an entity or institution has more monetary outflows than that of inflows. The term is commonly linked with the government spending rather than individual or business spending. Budget deficit essentially has an enormous impact on the economic conditions of the United States. It is also known as national debt, when it comes to federal governments' spending. Budget deficits can be curtailed by cutting down the expenditures, raising taxes or deficits to be supported by borrowing money. These strategies must be used in combination while borrowing must be done at the last resort since it worsens the deficit because of high interest accompanied (Osinubi et al, 2010).

Discussion

The growth of the economy brings prosperity to the country and enhances the economy that gives rise to the GDP of the country. The economic growth can be stimulated through various factors that include the role of financial intermediaries, role of government ownership of the banks and the social factors. The role of all these factors is crucial in the economic development of the country. Economic growth is the process by which per capita income rises over time. Growth theory attempts to model and understand the factors behind this process. It is a particularly challenging area of research because growth is extremely uneven in space as well as in time (Palley, 2011). Budget deficit certainly has a significant impact on the growth of economy. There have been several debates on this issue that how federal and provincial budget deficit affects the long term growth of the economy.

We can start with a simple example; if a government runs a deficit, it will finance its obligations through borrowing from the local public or through privatization. As a result of this transaction, the overall savings would be affected. It should be realized that saving is the amount available to investors for flourishing or opening up a new business. When this supply of funds decreases in the economy, it would result hike up the interest rates because of unavailability of funds and higher rate would discourage the firm participating in the loan. As a cyclical affect, people would borrow less and new investment would decrease since costs for loan becomes higher. This slow down of investment climate due to increase in government borrowing is referred as crowding out. Budget deficit directs the economy into a ferocious cycle, where deficits result in lower economic growth and in turn lead to lower tax revenue (Ocran, 2011). Lower tax revenue and higher government spending declines the economic activity even more and the only possible way to break this vicious cycle is by increasing tax rates and cutting government spending. Yet these tools rather lead to even higher deficits and slower economic growth. That's it is rightly named as called vicious cycle.

The US economic recovery has stuttered in recent months as high global oil prices, stemming from supply concerns in the Middle East, have pushed gasoline (petrol) ...