Prediction of OECD Regarding Budget Deficit in the USA Economy - Research Paper Example

?Business Economics Table of Contents Table of Contents 2 2 Prediction of OECD regarding Budget Deficit and Debt Concerning the USA Economy 3 DeficitReduction in Greek and Irish Government 4 Deficit Reduction in Greek Government 4 Deficit Reduction by Irish Government 5 Keynesian School of Thought 6 8 Impact of Credit Crunch on the Economy of the USA and the UK 9 References 11 Prediction of OECD regarding Budget Deficit and Debt Concerning the USA Economy The economic recession which broke out in the middle of 2008 had resulted in a wave of debt in several advanced economies along with the USA. When government spends more money compared to the amount it receives through tax, it requires borrowing to cover the gap. The amount that government borrows with subtraction of repay amount is called debt (Center for American Progress, 2011). Organisation for Economic Co-operation and Development (OECD) has predicted that government debt will increase seriously by unmaintainable levels in advanced as well as emerging economies within next 25 years. It is estimated that the standard principal deficit in the USA will be 2% of total Gross Domestic Product (GDP) in 2015 and will increase to 7.7% of total GDP by 2035. The baseline debt of the USA was 65% of total GDP in 2010, which is estimated to become 213% by 2035 (Gagnon & Hinterschweiger, 2011). Budget deficit occurs when government expends excess amount compared to what it gains through taxation. The opposite term of budget deficit is budget surplus when the outgoings are less than the receiving amount (Investopedia ULC, 2011). Even few years back, the US had budget surplus but due to the impact of the crisis in present days the US economy is running with budget deficit of 10% on GDP. It is expected that the budget deficit will decrease to 7% of GDP and by 2017 the government will seek to reduce the budget deficit to 3% of GDP (Paletta & Boles, 2011). Deficit Reduction in Greek and Irish Government Deficit reduction plan is helpful for advanced economies to deal with the economic recession. Several nations have implemented the debt reduction strategy to maintain a justifiable fiscal budget and to reduce the debt. Deficit reduction strategy can result in change of major economic and monetary players. It can help to achieve prospects of creditors which can ultimately reduce the financing budgets. It can be achieved by minimizing risk premium through ‘higher long-term interest’ (OECD, 2010). Deficit Reduction in Greek Government The Greek government had followed the deficit reduction plan in order to reduce their huge amount of deficits. In the year 2009, the deficit of Greece was 15.4% of GDP. The government of Greece had estimated a deficit of 9.4% in 2010. In order to reduce the deficit, Greece had adjusted its economic settings. The objective of deficit plan of Greece is to reduce government budget by decreasing expenses on public pays, annuities on public as well as private segments, and raise the revenue by increasing the rate of Value Added Tax (VAT), and taxes on gasoline, alcohol, and tobacco products. Greece’s deficit plan was to receive financial support from the EU nations and International Monetary Fund (IMF). Through this financial support, it is estimated that Greece can improve the economic growth and reduce the debt crisis. But, the deficit plan can have certain negative impacts on the economy. Reducing the monetary expenses can lead to fall on value of currency and stock market. Increasing taxes can also harm the lifestyle of people and can impact on the demand of products which may increase the problem of crisis. However, those who support the deficit plan say that delay in consolidating debt can worsen the economic condition even further (McCully & Webb, 2010). Deficit Reduction by Irish Government The debt crisis of Ireland is not similar as Greece, as it did not occur due to excess expenditures; rather it had occurred due to promising housing bubble in certain Irish banks. In order to crush budget deficit, Irish government had developed debt strategy. Irish government had decided to reduce the budget in order to deal with the debt crisis. In the year 2011, the government had announced a cut of 6 billion Euros which can help to decrease the shortfall to 9.25–9.5% of GDP. The expenditures and incomes are closely associated with each other. More saving has been made through reduction of expenses and increase of tax rates. Irish government has brought new offer for mortgage proprietors to estate a major amount of loan debt which lets their families to focus on incomes and enhancing the savings until their incomes become normal. This offer also stimulated banks to prolong present agreements for loan owners. Irish government anticipates that it can discharge the stress of debt which can offer people with more disposable incomes (BBC, 2011). Keynesian School of Thought Keynesian school of thought believes that an economy can suffer by high rate of unemployment with national productivity insistently lower than its potential. When the confidence of people dropped, they tend to save more which can make the crisis worse. The Keynesian stimulus is aimed to dynamically accomplish higher growth rate of aggregate demand. Keynesian theory depends on the demand side rule to raise the aggregate demand which can help to recover the economy. It can be accomplished by increasing the expenses of government which can in turn move the Aggregate Demand (AD) curve to the right. AD AD1 AD1 AD Shift in AD curve to the right can raise the price level (P1). As Y = C + G + I(x-m) [where Y = GDP; C= Consumption; I= Investment; G = Government expenditure; x = export and m = import], increase in Y will help to generate more jobs and reduce the unemployment. As a result people will earn more money which increases the tax proceeds of government. In classical condition, if government reduces the interference in the economy through reduction of taxes it can help to reduce the production cost which in turn moves the Aggregate Supply (AS) curve to the right which in turn increase the human capital (L). AS AS1 As a consequence, it can lead to higher equilibrium of GDP. Increase in GDP can generate employment and revenue for government which will be useful to deal with the debt crisis (Rose, n.d.). The change in AS/AD curve will bring a new equilibrium point which can impact on the spending pattern of government along with consumption pattern of people as well as the investment. In order to reduce the chances of gap between AS and AD equilibrium the government need to monitor the GDP trend of the economy and accordingly increase the expenses. Impact of Credit Crunch on the Economy of the USA and the UK The credit crunch is known as the vital cause for economic recession. The USA continued to expand the amount of loans and home mortgages to the subprime market. When people were unable to repay the amount of loan, banks started to lose huge amount of money. As every bank is connected with each other, the loaning had occurred between countries to deal with the money crisis. As the subprime market fell, banks had lost huge amount of money. The rescue effort made by the UK to deal with subprime crisis of the USA had generated credit crunch. As a result, both nations’ economies had suffered. In the year 2007, one of the leading European banks had announced first indication of crisis by loss of 10 billion USD through procurement of sub-prime mortgage. A mutual mistrust emerged within chief financial organizations in the international market and obtaining credit became much difficult for banks. In the UK, Northern Rock was the first victim of credit crunch which made the Bank of England to rescue it completely (International Labour Office, 2009). The costs of necessary products became more expensive whereas income of people remained same. Due to credit crunch the base rate of banks had decreased considerably. The turbulence in the financial market had reduced the GDP growth rate in both countries. In the USA, all the banks of Wall Street had faced remarkable losses. From 2007–2008, almost 430 billion USD from combined value of the market of the major investment banks in the US had disappeared and the total loss for lenders of mortgage was 162 billion USD (Yao & Et. Al., 2008). References BBC, 2011. Irish Republic Announces Record Budget Cuts. News Business. [Online] Available at: http://www.bbc.co.uk/news/business-11693654 [Accessed December 03, 2011]. Center for American Progress, 2011. What You Need to Know About the Federal Debt Limit. U.S. Debt Limit 101. [Online] Available at: http://www.americanprogress.org/issues/2011/04/pdf/debt_limit_101.pdf [Accessed December 03, 2011]. Gagnon, J. E. & Hinterschweiger, M., 2011. The Global Outlook for Government Debt Over The Next 25 Years. Peterson Institute for International Economics. [Online] Available at: http://www.piie.com/publications/chapters_preview/6215/iie6215.pdf [Accessed December 03, 2011]. Investopedia ULC, 2011. What Does Budget Deficit Mean? Budget Deficit. [Online] Available at: http://www.investopedia.com/terms/b/budget-deficit.asp#axzz1fMN18NVq [Accessed December 03, 2011]. International Labour Office, 2009. How The Crisis Started. Impact of the Financial Crisis on Finance Sector Workers. [Online] Available at: http://www.ilo.org/wcmsp5/groups/public/@dgreports/@dcomm/documents/meetingdocument/wcms_103263.pdf [Accessed December 03, 2011]. McCully, T., & Webb, M., 2010. Greece’s 2011 Budget Reinforces The Country’s Deficit Reduction Plans. Greece-X-Press. [Online] Available at: http://scotiabank.com/ca/common/pdf/about_scotia/grbudget.pdf [Accessed December 03, 2011]. OECD, 2010. Restoring Fiscal Sustainability: Lessons for the Public Sector. Public Governance Committee. [Online] Available at: http://www.oecd.org/dataoecd/1/60/44473800.pdf [Accessed December 3, 2011]. Paletta, D. & Boles, C., 2011. White House Expects Deficit to Spike to $1.65 Trillion. Dow Jones & Company, Inc. [Online] Available at: http://online.wsj.com/article/SB10001424052748703361904576143253522341850.html [Accessed December 03, 2011]. Rose, A., No Date. Circular Flow of Income. Haas School of Business. [Online] Available at: http://faculty.haas.berkeley.edu/arose/Macro2.pdf [Accessed December 03, 2011]. Yao, S. & Et. Al., 2008. Impact Of The Us Credit Crunch And Housing Market Crisis On China. China Policy Institute. [Online] Available at: http://www.nottingham.ac.uk/cpi/documents/briefings/briefing-43-us-credit-crunch-housing-market-crisis-on-china.pdf [Accessed December 03, 2011]. Read More