Congressional Research Service. Congressional Budget Office. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money.
Personal Finance. Your Practice. Popular Courses. Part Of. Capitalism vs. Communism vs. Budget Deficit. What Is a Budget Deficit? Key Takeaways A budget deficit happens when current expenses exceed the amount of income received through standard operations.
Certain unanticipated events and policies may cause budget deficits. Countries can counter budget deficits by raising taxes and cutting spending.
Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation.
It begins with the mainstream view, and then explains how other versions differ from that view. In the mainstream economic view, budget deficits expand total spending aggregate demand , and thereby short-term economic growth. If a budget deficit is the result of tax cuts, aggregate spending is expanded by an increase in spending by the tax cut's recipients.
In an economy operating at full employment, production aggregate supply cannot be increased to match the increase in spending because all of the economy's labor and capital resources are already in use. This mismatch between aggregate demand and aggregate supply must be resolved through market adjustment. Market adjustment takes place in four distinct ways, each of which has consequences for interest rates.
As a result of the interaction between these market forces, resources have been shifted toward the government or tax cut recipients and away from the saving of the private sector. This has consequences for the economy in the long run. In the long run, economic growth is dependent on increases in private investment, productivity, and the labor force. By identity, private investment equals national saving less the budget deficit foreign saving will be considered below.
Thus, by reducing national saving, budget deficits lead to less private investment. This reduces the size of the economy in the long run, and future standards of living. If the deficit lasted for several years, it would reduce growth for the duration of that time. For this reason, economists often describe deficits as placing a burden on future generations.
Deficits allow individuals to enjoy more consumption today. But since this higher consumption comes at the expense of lower saving, and hence lower investment, it reduces the size of the economy in the future. Thus, individuals would enjoy lower consumption in the future. Thus far, it has been assumed that the expansion in the budget deficit was taking place in an economy with fully employed resources. Since all of the economy's resources were already in use, for the government to redirect resources to itself or tax cut recipients required a reduction in the resources available to others.
This reallocation occurred through higher prices and interest rates, the latter of which "crowded out" private investment and consumer durables. But in an economy with underemployed labor and capital resources as a result of a recession or low growth, the financing of a budget deficit is no longer a zero-sum scenario in which any resources redirected to the government or tax cut recipients must be fully offset by a reduction in the purchasing power of others.
That is because the increase in aggregate spending caused by the deficit leads to unemployed resources being brought back into use, generating new aggregate production to match the increase in aggregate spending. This is how expansionary fiscal policy "stimulates" the economy during a recession.
In an extremely underemployed economy, enough unused resources are available to match the increase in aggregate spending entirely. The increase in the budget deficit would be "multiplied" by the fact that re-employed workers increase their spending as well, so that the total increase in aggregate spending is larger than the increase in the budget deficit. In this case, the budget deficit would be unlikely to have much of an effect on interest rates and inflation, as long as it were eliminated once the economy returned to full employment.
The U. In all recessions since the s, including the last one, some underemployed resources have been available to be brought into use in response to an increase in aggregate spending, but not enough so that there would not be any increase in interest rates or prices within the framework of the conventional model. Thus, expansionary fiscal policy would cause some increase in aggregate spending, with larger increases the further the economy is from full employment.
It would also cause some increase in interest rates and prices, but less than in a fully employed economy.
During the past couple of years, the economy has been close to economists' estimate of full employment, so the effect of deficits on interest rates and prices would be expected to be greater. If prices and markets do not adjust instantaneously and people's expectations do not change instantaneously, even at full employment it may be possible to temporarily bring additional resources into production, thereby generating some transient stimulus from an increase in the budget deficit.
In other words, an increase in the deficit is unlikely to ever lead to zero increase in aggregate spending in the very short run. However, a deficit is likely to lead to a much smaller increase in output and larger increase in prices at full employment than in a recession.
And after adjustment took place, the economy would return to full employment, with the same higher interest rates and prices as described in the previous section.
Economists tend to disfavor attempts to push the economy above full employment in this way, since the inevitable move back down to full employment could result in overshooting in the opposite direction—recession. Thus far, the mainstream model described has used the assumption that the United States is a closed economy, in which trade and capital does not flow between it and the rest of the world. Relaxing this assumption has very important ramifications for interest rates.
In a closed economy, the pool of savings available to the government to finance its deficits and the private sector to finance its investment spending is fixed. For that reason, any increase in the demand for that savings must push up interest rates.
But what if the firms and government of the United States could draw from the world pool of savings, rather than being limited to the national pool of savings? If the increase in the deficit were an insignificant fraction of world savings, it would have no effect on world interest rates.
Any time U. Although with perfect capital mobility, a deficit would have no effect on interest rates, a deficit would still have a cost to the economy. First, although the foreign capital inflows permit a larger U. However, U. The second cost comes from the effect the capital inflow has on the economy. For foreign capital to enter the country, foreigners must buy U.
The increased demand for dollars causes the dollar exchange rate to appreciate. As the dollar appreciates, U. This causes the trade deficit to expand, which reduces aggregate spending in the economy. In a world of perfectly mobile capital, the expansion in the trade deficit would offset the expansion of fiscal policy one-to-one, so that fiscal stimulus had no net effect on aggregate spending.
By adding capital mobility, crowding out has not been eliminated, it has been shifted from the investment sector to the trade sector. Thus, although there is no effect on interest rates, fiscal policy in this scenario no longer has any stimulative effect on the economy.
Whereas the burden of deficits was borne by future generations in a closed economy, in the presence of perfect capital mobility, it is borne by U. In the conventional view, simple assumptions are made about the behavior of private saving in response to a budget deficit. If the deficit is the result of a tax cut, the conventional view assumes that the tax cut's recipient would save a fraction of that tax cut and spend the rest.
Although there is no direct way to measure how much of a tax cut recipients would be likely to save, since the average household saving rate is very low it averaged 4. Therefore, the rise in private saving would be much smaller than the fall in public saving and little crowding out would be prevented. If saving is highly sensitive to changes in interest rates, small increases in the after-tax rate of return as a result of lower marginal tax rates could lead to large increases in saving technically, saving would be said to have a high and positive interest elasticity.
If the interest elasticity of saving were great enough, this would keep the budget deficit from causing large changes in interest rates, and hence investment. The corporate saving rate has been relatively constant in the post-war period, while the household saving rate has dropped considerably in the past two decades.
The downward trend in the household saving rate has occurred during a period with many changes in marginal tax rates, including large reductions in top marginal income tax rates, marginal tax rates on investment income, and the expansion of tax-preferred savings vehicles in the s and the s.
It is also worth considering, from a theoretical perspective, that private saving could be sensitive to interest rates in the opposite way. Rather than saving more in response to higher interest rates, individuals could save less. If individuals are primarily target savers, saving to meet a goal such as owning a house, car, or to support a certain standard of living in retirement, higher interest rates would make that goal easier to meet.
This would cause them to save less in response to a budget deficit, making the deficit's negative effect on long run growth even greater than under the conventional view. Thus, even if incentives are an important determinant of saving behavior, it is not clear in which direction the incentives cause behavior to react. And there is no straightforward evidence to suggest which view is correct.
Indeed, the rapidly rising stock market in the late s coincided with a decline in the household savings rate to nearly zero, as the target-saver view would predict. Are there explanations that suggest a larger private saving response to a budget deficit? Some economists complain that the explanation of how savers react to changes in the government's fiscal position is not well developed in the mainstream view.
There is no explanation of how today's policy decisions affect the future, and how individuals incorporate their perceptions of the future into their plans today.
The Barro-Ricardo view, named after the 19 th century economist David Ricardo, and Robert Barro who revived and developed Ricardo's theory, addresses this issue. Barro assumed that people were perfectly rational, planned their lifetime consumption through optimization, had infinite life spans he suggested that concern for offspring on par with one's own well-being could substitute for infinite life spans in reality , could borrow against future earnings without limit, and were all taxed equally.
If the deficit finances government purchases, those purchases must be perfect substitutes for private consumption. He assumed that if the deficit finances tax cuts, the tax cut was lump-sum in nature, so that incentives to work or save are not changed. Under these circumstances, he reasoned, individuals would know that any increase in the budget deficit would have to be offset by an increase in their tax burden or decrease in their government services in the future.
To make up for the reduction in future consumption brought about by the deficit, they would save more now. Thus, as the government placed greater demand on the nation's savings, the pool of savings would expand, so that no upward pressure was placed on interest rates.
Since interest rates and investment levels are the same, long-term growth would be the same. This also means that an increase in the budget deficit would have no short-run stimulative effect on the economy since national saving and thus aggregate spending has stayed the same— the stimulus provided by the government has been offset by a contraction in private spending.
As can be seen, the fact that interest rates do not rise in the Barro-Ricardo view does not mean that deficits can be financed without using any resources.
Instead of transferring resources from the investment sector as in the conventional view , or the trade sector as in the capital mobility view , the resources are transferred from private consumption. In this sense, the effect of a deficit under the Barro-Ricardo view is similar to a tax increase: resources are transferred to the government through a reduction in private consumption. The Barro-Ricardo view has a clear advantage over the conventional view: it offers an explanation for how individuals adjust their saving behavior to take into account fiscal policy.
But the strict conditions adopted to make this explanation tractable are also its greatest weakness. If any of the highly exacting prerequisites are weakened, the results may no longer hold.
For example, what if individuals do not plan out their lifetime consumption because of uncertainty or myopia? While macroeconomic proposals under the Keynesian school argue that deficits are sometimes necessary to stimulate aggregate demand after a monetary policy has proven ineffective, other economists argue that deficits crowd out private borrowing and distort the marketplace. Still, other economists suggest that borrowing money today necessitates higher taxes in the future, which unfairly punishes future generations of taxpayers to service the needs of or purchase the votes of current beneficiaries.
If it becomes politically unprofitable to run higher deficits, there is a sense that the democratic process might enforce a limit on current account deficits.
Federal Reserve Bank of St. Paul Krugman. International Monetary Fund. Bipartisan Policy Center. Accessed Jan. Department of Defense. Joint Committee on Taxation.
Download "JCX Kaiser Family Foundation. The White House. Board of Governors of the Federal Reserve System. Smithsonian Magazine. Federal Reserve. Fiscal Policy. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.
These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification.
I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Economics Macroeconomics. Table of Contents Expand. Impact on the Economy. Fiscal Deficit. Impact in the Shorter-Term. Financing a Deficit. Federal Limits on Deficits. A Historical Perspective. Upside of Deficits. Downside of Deficits. The Bottom Line. Key Takeaways A government experiences a fiscal deficit when it spends more money than it takes in from taxes and other revenues excluding debt over some time period.
This gap between income and spending is subsequently closed by government borrowing, increasing the national debt. An increase in the fiscal deficit, in theory, can boost a sluggish economy by giving more money to people who can then buy and invest more.
Long-term deficits, however, can be detrimental for economic growth and stability. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.
You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
0コメント