Deficit

From Wikipedia, the free encyclopedia

A budget deficit occurs when an entity (often a government) spends more money than it takes in. The opposite is a budget surplus. Debt is essentially an accumulated flow of deficits. In other words, a deficit is a flow and debt is a stock.

An accumulated deficit over several years (or centuries) is referred to as the government debt. Government debt is usually financed by borrowing, although if a government's debt is denominated in its own currency it can print new currency to pay debts. Monetizing debts, however, can cause rapid inflation if done on a large scale. Governments can also sell assets to pay off debt. Most governments finance their debts by issuing long-term government bonds or shorter term notes and bills. Many governments use auctions to sell government bonds.

Governments usually must pay interest on what they have borrowed. Governments reduce debt when their revenues exceed their current expenditures and interest costs. Otherwise, government debt increases, requiring the issue of new government bonds or other means of financing debt, such as asset sales.

According to Keynesian economic theories, running a fiscal deficit and increasing government debt can stimulate economic activity.

[edit] Debt formula

A formula to calculate debt <math>D</math> at time t , is:

where <math>r</math> is the interest rate, <math>D_{t-1}</math> is last year's debt, <math>G_t</math> is government spending, <math>T_t</math> is tax revenue, and <math>z_t</math> are other government revenues such as tariffs.

Economic trends can influence the growth or shrinkage of fiscal deficits in several ways. Increased levels of economic activity generally lead to higher tax revenues, while government expenditures are often increase during economic downturns because of higher outlays for social insurance programs such as unemployment benefits. Changes in tax rates, tax enforcement policies, levels of social benefits, and other government policy decisions can also have major effects on public debt. For some countries, such as Norway, Russia, and members of the Organization of Petroleum Exporting Countries (OPEC), oil and gas receipts play a major role in public finances.

Inflation reduces the real value of accumulated debt. If investors anticipate future inflation, however, they will demand higher interest rates on government debt, making public borrowing more expensive.

[edit] Early deficits

Before the invention of bonds, the deficit could only be financed with loans from private investors or other countries. 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.

[edit] 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 the general level of government spending is too high for prevailing tax levels.

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.

[edit] Largest national budgets (2004)

(This data is from 2004, the year of the largest US federal deficit on record. Since that time, the size of the deficit has been cut, nearly in half.) (Data from CIA Factbook and List of countries by GDP (nominal), senate.gov, nasbo.org)

[edit] Miscellaneous

Ricardian equivalence hypothesis, named for the English political economist and Member of Parliament David Ricardo, states that because households anticipate that current public deficit will be paid through future taxes, those households will accumulate savings now to offset those future taxes. If households acted in this way, a government would not be able to use fiscal policy to stimulate the economy. The Ricardian equivalence result requires strong modelling assumptions. For example, the result requires that households act as if there were infinite-lived dynasties. Empirical evidence on Ricardian equivalence effects has been mixed.

[edit] See also

• Fiscal Policy in the United States
• National debt by U.S. presidential terms
• Starve-the-beast philosophy
• U.S. public debt

[edit] External links

• U.S. Congressional Budget Office
• Hong Kong Government Budget
• The Budget Graph: A graphical representation of the 2008 United States federal discretionary budget, including the public debt.
• United States - Deficit versus Savings rate from 1981 Historical graphical representation of the 12 month rolling Fiscal deficit versus the Savings rate of the United States. (since 1981)ba:Дефицит

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