Deficit

From Free net encyclopedia

This article relates to budget deficit. For trade deficit, see balance of payments

A budget deficit occurs when an entity (often a government) spends more money than it takes in. The opposite is a budget surplus.

The size of a governmental budget deficit is often an important political issue as well as one of economic policy. Fiscal conservatives denounce deficit spending and advocate balanced budgets. Keynesians argue that under some circumstances, deficit spending is justified. "Starve-the-beast" strategies usually lead to high budget deficits.

An accumulated deficit over several years (or centuries) is referred to as the government debt. Often, a certain part of spending is dedicated to paying of debt with certain maturity, which can be refinanced by issuing new government bonds. That is, a fiscal deficit leads to an increase in an entity's debt to others. A deficit is a flow. And a debt is a stock. Debt is essentially an accumulated flow of deficits.

Any deficit must, ultimately, be repaid, either through taxation, or seignorage. The Ricardian equivalence hypothesis states that this means a public deficit is exactly the same as a tax rise.

The existence of a deficit has in some cases led to the existence of a capital market and been a great benefit to economic activity.

To calculate debt is: Debt = RBt-1 + (r-g)Gt - Tt R= real interest rate. Bt-1= Debt of last year. r = Interest Rate g= growth rate Gt= Government Spending Tt = Tax Revenue.

1 Early Deficits
2 Structural and Cyclical Deficits
3 Inflationary consequences of deficits
4 Top Ten National Budgets (2004)
5 See also
6 External links

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Early Deficits

Before the invention of bonds, the deficit could only be financed with loans from private investors. A prominent example of this was the Rothschild dynasty in the late 18th and 19th century, though there were many earlier examples.

These loans became popular when private financiers had amassed enough capital to provide them, and when governments were no longer able to simply print money, with consequent inflation, to finance their spending.

However, large, long-term loans had a high element of risk for the lender and consequently gave high interest rates. Governments later tried to marketize their debts by issuing bonds that were payable to the bearer, rather than the original purchaser. This meant that someone who lent the state money could sell on the debt to someone else, reducing the risks involved and reducing the overall interest rates. Examples of this are British Consols and American Treasury bill bonds.

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Structural and Cyclical Deficits

A government deficit can be thought of as consisting of two elements, structural and cyclical.

At the lowest point in the business cycle, there is a high level of unemployment. This means that tax revenues are low and expenditure (e.g. on social security) high. Conversely, at the peak of the cycle, unemployment is low, increasing tax revenue and decreasing social security spending. The need to borrow money at the low point of the cycle is a cyclical deficit. A cyclical deficit will be entirely repaid by a cycical surplus at the peak of the cycle.

A structural deficit is the deficit that remains across the business cycle, because general tax levels are too low for the general level of government spending.

The observed total budget deficit is equal to the sum of the structural deficit with the cyclical deficit or surplus.

The idea of cyclical vs. structural deficits has come under criticism by those economists who believe that the business cycle is too difficult to measure to make cyclical analysis worthwhile.

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Inflationary consequences of deficits

As a nation borrows to maintain its spending, it is in effect increasing the money supply, because the government is promising to give money at a later date.

According to the quantity theory of money, this will inevitably cause inflation down the line. Furthermore, the seignorage that the government gains from the inflation will be equal to the debt the government incurred originally. The expected inflation will increase nominal interest rates.

Some governments compensate for this by requiring the central bank to increase its holdings of government debt. This neutralises the monetary effect of the deficit. However, it does raise the real interest rate, because there are now more borrowers seeking the same supply of loanable funds. (See real versus nominal value for an explanation of the terminology)

At some point, however, it is necessary as resources become finite that a government cannot sustain itself on credit. Bankruptcy is the end result. This implosion leads to social unrest and generally some form of revolution as inflation escalates consumer prices beyond norms that can be largely sustained by the masses of society.

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Top Ten National Budgets (2004)

**National Government Budgets for 2004 (bn US$)**
Nation	GDP	Revenue	Expenditure	Exp / GDP	Budget Deficit	Deficit / GDP
US (federal)	11700	1862	2338	19.98%	-25.56%	-4.07%
US (state)	-	900	850	7.6%	+5%	+0.4%
Japan	4600	1400	1748	38.00%	-24.86%	-7.57%
Germany	2700	1200	1300	48.15%	-8.33%	-3.70%
UK	2100	835	897	42.71%	-7.43%	-2.95%
France	2000	1005	1080	54.00%	-7.46%	-3.75%
Italy	1600	768	820	51.25%	-6.77%	-3.25%
China	1600	318	349	21.81%	-9.75%	-1.94%
Spain	1000	384	386	38.60%	-0.52%	-0.20%
Canada	900	150	144	16.00%	+4.00%	+0.67%
South Korea	600	150	155	25.83%	-3.33%	-0.83%