Budget Deficits


Budget deficits are not uncommon to modern day economics. Budget deficits arise when the public expenditure exceeds the government receipts. There are times when these deficits arise due to deliberate government policies and there are times they arise unexpectedly due to the nature of business cycles.

There are times when these large deficits are as a result of the private sector behavior and there are times when they are caused by the public behavior. In an economic sense the private sector can cause a large government deficit when their actions lead to increased imports either of consumer or industrial goods.

In essence when these large imports are in the form of industrial goods this is usually not a bad situation since the increased capital expenditure leads to increased economic performance that will ultimately offset the deficit in the long run. On the other side when this increased expenditure is meant for purchase of consumer goods or luxury goods this does not auger well in the long run since there is no explicit mechanism to reverse back the deficit.

On the other side it might be as a result of deliberate government action. In the case of the United States the current federal budget deficit is caused by both the private and the public sector. The private sector has contributed through increased imports especially from china which has ultimately led to a negative balance of trade between china and the United States in the favor of china.

Budget Deficits

The government has contributed to this especially in the form of increased financing for the war in Iraq and Afghanistan. The bush administrations 1.3trillion tax cut (the largest in U.S history) has also contributed highly to this federal budget deficit.


Many governments do operate normally on large budget deficits, like the Australian government. Regardless of this fact the sustainability of these deficits needs to be assured since failure to do so can lead to a form of economic suicide.

In the case of the United States many avenues do exist to turn around the situation these include: increasing federal taxes, cutting down on public expenditure e.g. reducing farm subsidies, limiting or cutting down on social benefits or cutting expenditure on some programs like space exploration. All these avenues have their merits and demerits.

The advantages or disadvantages can not be viewed from a domestic perspective only but also an international perspective since some of these policies affect even international trade.

Using the production possibilities curves we can assume that if the deficit has been caused by both the private and public sector then we expect the production probability curve to have moved outwards (to the right) for both investments and future production.

Budget Deficits

This in the long run will lead to increased productivity. In the figure below this is depicted by movement from ppc1 to ppc2. now incase the government was to contain this by the use of fiscal policy measures(increased taxation) then this would lead to reduced investments and a decline in future productivity and the production possibility curve would shift from ppc2 and move inwards (to the left). This shift would depend on the level of increased taxation and the curve would be anywhere to the left of ppc2.

Incase the government was to instead consider cutting down on some programs like social benefits or loans to university students then this would course some social net loss as the affected members of the society might end up being more poorer as the increased cost of livelihood could even condemn them to a life below the poverty line. This would not auger well since every government usually pledges to reduce the levels of poverty and enhance access to social services to the unprivileged.

In this case the opportunity cost of the cut in government programs to the society would be a negative life standard and this shows that this would not be a worth while government policy to undertake.

Now let’s consider if the economy was not a mixed economy but instead was a free market structure. This would be analyzed on the invisible hand principle. Using this principle would entail the market regulating itself to equilibrium. In the case above since the production possibilities curve has already moved/shifted outwards the market would allow the deficit to persist in the short run but as investments increase and production increases then the free market would gradually reduce imports of both industrial and consumer goods.

This would leave the production possibilities curve at ppc2 and as the market increases exports

Budget Deficits

arising from increased productivity the budget deficit would gradually come down and if the export market is very lucrative then a budget surplus would be something not to be unexpected in the long run.

The issue of capitalism and socialism on an economic perspective. Capitalism is a different mode of production from socialism as east is from west. Deciding to change the ideological mode of production would entail not only economic changes but also political and social. This would be the most expensive effort and though we don’t have the evidence to prove this would surely cause every multinational company located in American soil to relocate to a more friendly location abroad. This would almost certainly lead to a total collapse of the American economy.

The issue of good economics versus good politics can also be analyzed on an economic perspective. Here is where all the challenge lies. In this case a mixture of monetary and fiscal policies should be employed on the government side. Here the government should attempt to sustain the current level of government deficit by direct involvement in the economy through some moderate tax increases compounded by some monetary policy decision to lower interest rates.

This if effected properly would leave production capacity unaffected although through the increased tax would scale down the federal deficit. On the same issue good politics would ensure that the government would not undertake expensive ventures as long as it does not have a mechanism to finance the venture e.g. the Iraq war that seems to be running out of control.


Sustainable budget deficits can be sometimes good to increase the productivity of any economy. However to have a sustainable deficit in a global economy is very challenging and a

Budget Deficits

harmonious correlation between the fiscal and monetary policies needs to exist. In addition the private sector behavior needs to be regulated since it can be and is usually a cause of unsustainable budget deficit.

Budget Deficits