Consequences of a Budget Deficit
- Many countries continue to run a budget deficit year after year
- A deficit must be financed through borrowing from somewhere
- Borrowing from outside the country (external borrowing) may cause political vulnerabilities
- Singapore only borrows from its own citizens (internal borrowing), which reduces the risk of external pressure on their policies
Diagram: Consequences of a Budget Deficit
Running a budget deficit enables a government to spend more than it receives
Explaining the Consequences
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Consequences of a Deficit
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Explanation
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National debt increases
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- National debt rises as the government spends more than it takes in. This money has to be paid back with interest
- There is a burden on future generations, as they are left with large interest payments on the debt
- This creates an opportunity cost as future governments may have to cut spending on services, in order to repay the debt
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Inflationary pressures
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- A deficit can cause the economy to overheat, as governments spend more money (injects more than it withdraws)
- This causes demand pull inflation, as there is more money in circulation
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Economic shocks
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- The economy is more vulnerable to economic shocks
- If there is no surplus set aside in the event of a shock (e.g. Covid), then the ability to respond is limited
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Economic growth
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- If the borrowing is to be spent as increased government spending, the economy may benefit in the short to medium term
- However, more borrowing may cause inflation, which can lead to a rise in interest rates to curb that inflationary pressure
- Higher interest rates will discourage investment by firms and also cause the nation's currency to appreciate, meaning that its exports are less price competitive
- In the longer term, fewer investments and exports, together with higher interest payments on the debt, may cause AD to fall and lead to lower levels of economic growth
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