Budget Deficit - Explained
What is a Budget Deficit?
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Table of ContentsWhat is a Budget Deficit?Why the Budget Deficit is ImportantThe Danger of Budget DeficitsStrategies to Reduce Budget DeficitsReal-World ExampleAcademics Research on Budget Deficit
What is a Budget Deficit?
A budget deficit is an accounting situation that happens when expenses exceed income. Individuals, corporate organizations and even the government can experience budget deficit, it means more money was spent than earned. A budget deficit usually reflects in the financial statement, it is an indicator that there were fewer revenues recorded for the year but more expenses.
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Why the Budget Deficit is Important
A budget deficit creates an accounting loss, it shows that no gain was recorded, rather, expenses were more than the money earned. Individuals, corporate organizations and the government take diverse measures to reduce the budget deficit. The most common ways to tackle this situation is through reduced spending and a higher income. Reducing expenditures and engaging in activities targeted at generating revenue help to reduce our correct the amount of deficit that occurs in a budget. Furthermore, there are certain activities that can increase a budget deficit, this includes heavy borrowing. The largest budget deficits were recorded in the 20th century, this was when most countries had greater expenditures than their revenue. Here are the important points to know about a budget deficit:
- A budget deficit occurs when expenses (expenditures) exceed income (revenue).
- A Budget surplus is the opposite of a budget deficit, this occurs when revenue exceeds expenses.
- Individuals, organizations and governments can have a budget deficit.
- There are some measures that can control a budget deficit, these are increased revenue and reduction in expenditure.
The Danger of Budget Deficits
A budget deficit poses a lot of dangers to a country, a corporation or an individual when it occurs. One major danger of Budget deficit is inflation which in the long run will cause a recession. A prolonged budget deficit is bad for an economy, this is why governments devise several strategies to control budget deficits.
Strategies to Reduce Budget Deficits
Ultimately, corporations and governments want to control our reduce budget deficits. Some of the strategies that help control budget deficits are;
- Reducing government spending and expenditure.
- Increasing government revenue, this can be achieved through fiscal policies such as increasing taxes paid to the government.
- Printing of additional currency, in order to have more circulation of money in the country and settle all debts.
- Boosting business confidence through fewer regulations.
There are certain activities that can cause budget deficits, a good example was during the World War when governments engaged in heavy borrowing to finance the war. This action was also backed up by a depletion of the federal reserves to facilitate the war, this caused budget deficits which lasted till the 1960s for most countries. Defense spending during terrorism attacks can also lead to budget deficits. The United States spent heavily on defense after the September 11 terror attacks which caused a budget deficit. A budget deficit is presented as a percentage of the GDP of a country.
Academics Research on Budget Deficit
- Voting on thebudget deficit, Alesina, A. F., & Tabellini, G. (1988). Voting on the budget deficit.
- Is thebudget deficittoo large?, Hakkio, C. S., & Rush, M. (1991). Is the budget deficit too large?.Economic inquiry,29(3), 429-445. Yes. Specifically, we find that recent spending and taxing policies of the governmentif continuedviolate the government's intertemporal budget constraint. As a result, government spending must be reduced and/or tax revenues must be increased. These conclusions are based on tests of whether government spending and revenue are cointegrated. In addition to examining real spending and revenue, we also normalize these variables by real GNP and population. For a growing economy, these normalized measures are perhaps more pertinent. We also test and find support for the hypothesis that deficits have become a problem only in recent years.
- The budget deficit and the dollar, Feldstein, M. S. (1986). The budget deficit and the dollar.NBER Macroeconomics Annual,1, 355-392. This study examines the reasons for changes in the real exchange rate between the dollar and the German mark from the beginning of the floating rate regime in 1973 through 1984. The econometric analysis focuses on the effects of anticipated structural budget deficits and monetary policy in the United States and Germany and the changes in U.S. profitability induced by changes in tax rules. The possible impact of a number of other variables is also examined. The evidence indicates that the rise in expected future deficits in the budget of the U.S. government has had a powerful effect on the exchange rate between the dollar and the German mark. Each one percentage point increase in the ratio of future budget deficits to GNP increased the exchange rate by about 30 percentage points. Changes in the growth of the money supply also affect the exchange rate. Changes in tax rules and in the inflation-tax interaction that altered the corporate demand for funds did not have any discernible effect on the exchange rate. A separate analysis confirms that there is an equilibrium structural relation between the dollar-DM exchange rate and interest rates in the United States and Germany. An increase of one percentage point in the real interest rate differential has been associated with a rise in the DM-dollar rate of about 5 percent.
- Budget deficitpersistence and the twin deficits hypothesis, Normandin, M. (1999). Budget deficit persistence and the twin deficits hypothesis.Journal of International Economics,49(1), 171-193. This paper gauges the twin deficits hypothesis, i.e. a positive causal relationship between the external and budget deficits. This relationship is measured by the responses of the external deficit to changes in the budget deficit induced by Blanchard's model. These responses are positively affected by the birth rate and by the degree of persistence of the budget deficit. Empirical results for the Canadian and US economies reveal that, although the relevant birth rates are small, the great persistence of the budget deficits yields responses that are numerically large and statistically positive. This contrasts with previous tests of the twin deficits hypothesis, which have never formally taken into account the stochastic properties of the budget deficit.
- Is thebudget deficittoo large?: some further evidence, Tanner, E., & Liu, P. (1994). Is the budget deficit too large?: some further evidence.Economic Inquiry,32(3), 511-518. The size of the federal budget deficit has alarmed politicians and the general public both. Following recent work, we examine the longrun solvency of the U.S. government by testing for cointegration of federal expenditures and revenues. We include a break term in the cointegrating recession for 1981 to capture a shift in the fiscal process in the first Reagan administration. Tests show the break to be significant; and with the break, in contrast to earlier work, expenditures and revenues are cointegrated with a coefficient of one. Thus, we find the deficit to be stationary and so potentially sustainable.
- Framing and the public agenda: Media effects on the importance of the federalbudget deficit, Jasperson, A. E., Shah, D. V., Watts, M., Faber, R. J., & Fan, D. P. (1998). Framing and the public agenda: Media effects on the importance of the federal budget deficit.Political Communication,15(2), 205-224. What explains the shift in public opinion over time on the issue of the 1996 U.S. federal budget? Public opinion polls demonstrate dramatic shifts in the percentage of people considering the budget issue to be the most important problem facing the country from November 1994 through April 1996. In this article, we model Roper Center opinion polls against a prediction of opinion from media content to investigate how media coverage affects the importance assigned to the budget issue. We identify four dominant frames present in media coverage of the budget issue and argue that a model combining the theories of agenda setting and framing provides a better explanation for the shifts in aggregate opinion than either theory on its own. By combining framing with the traditional agenda-setting approach, we take into account the nuances of cover age within the issue, in addition to the sheer amount of cover age, for a more complete explanation of media effects on public opinion on the issue of the federal budget. Thebudget deficit, public debt, and endogenous growth, Bruninger, M. (2005). The budget deficit, public debt, and endogenous growth.Journal of Public Economic Theory,7(5), 827-840. This paper analyzes the effects of public debt on endogenous growth in an overlapping generations model. The government fixes the budget deficit ratio. If the deficit ratio stays below a critical level, then there are two steady states where capital, output, and public debt grow at the same constant rate. An increase in the deficit ratio reduces the growth rate. If the deficit ratio exceeds the critical level, then there is no steady state. Capital growth declines continuously, and capital is driven down to zero in finite time.