Counter Point on Budget Deficit

Counter Point on Budget Deficit

Point

Budget is a planning tool that helps governments, organizations and project developers in outlining the future expectations in a quantitative manner. Budgeting is forecasting tool which is used to predict the results that will arise in the future. Governments provide budgets on yearly basis to provide the public view of the government spending and the revenues in the years to come. If the government expenditures increase more than the revenues then it is a situation where the economy faces budget deficit. There are many points in favor and against of the argument that a larger deficit results in higher interest rates. For Example, there is no clear relationship between budget deficit and the increasing interest rate. It has happened that in many countries for example Canada had largest surplus from 1998 to 2000 and also had the high rate of interest rate. On the other hand Japan during the same time period had the largest budget deficit but the interest rate was low in the country. Thus the researcher concluded that in case of a larger fiscal budget it is not necessary that it results in higher interest rate.

Counter Point

According to Makin (2012) factors like increasing interest rates, inflation, recession, unemployment all results due to a larger amount of budget deficit. The researcher concluded with the views of Keynesian schools of thoughts that deficit can result due to either increase in government spending or due to the reduction in taxes. Keynesian gave their view that increasing government spending will decrease the unemployment and will make the household consumers wealthier. For example, No new projects started by the government will not create jobs for the people thus GDP and growth will decline, thus it will lead towards increase in the interest rates.

The increasing demand of money rises which leads to a rise in the interest rate and thus the investment in the country will decline. If the spending of the government is based on the debt finances then the public debt will rise and as a result constant supply of money will lead towards an illiquid composition of money and bonds. Therefore it will lead towards a rise in interest rates. For example, Money supply will increase in the economy which will decrease the value of the currency and thus government will have to increase the interest rate to control the money supply, as increasing interest rates will reduce the spending of the people.

There are two financial assets due to which the interest rate rise or decline in an economy, these are bonds and money supply. Thus the interest rate is determined according to the allocation of portfolio decision taken on the basis of stocks of bond and the money. The investors on the basis of liquidity preference demands higher interest rate in order to hold a more illiquid asset portfolio. Therefore interest rate reduces the investment and output consequently. Apart from the demand of money, the wealth effect will lead towards a ...