QUESTION 1 Assume the federal government runs huge budget deficits today to finance, say, Social Security, Medicare, and other programs for elderly, and finances these deficits by selling bonds that raises interest rate. …
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Financing deficit by borrowing in the futures through bonds with a premium interest is not a good prescription to finance additional expenditures. Running a budget deficit places upward pressure on interest rates (Arestis & Sawyer, 2010, pg.328) When a government has to raise money, which in this case is to finance Social Security, Medicare or other programs for the elderly, one of the tools it can use to sell bonds or promissory notes which the buyer or investor can cash in at a maturity date which the government guarantees. Raising money for such laudable programs is not a problem, only the method it is being raised in this case because it has a contagion or ripple effect in the other sectors of the economy. We all know that business needs capital either to start or to expand. Business is essential in a given economy as it does not only pays taxes for the government to spend on its programs but it also provides jobs which in turn yields more taxes to the government through the income tax of the employees. Also, it produces goods and services which other entities may utilize to create value and in the process also yields tax to the government. Suffice to say, business is important in the over-all health of any given economy. Business also incurs costs; either for its operation or the overhead of maintaining itself to be a going concern as a business. One of the expenses it has to pay is interest expense or the cost of money. It is necessary for business needs additional capital for it to expand and respond to competition, changing technology or to simply adapt with the times to remain competitive. So when interest rates are jacked up to invite investors to avail the bonds for the government to finance the spending on Social Security, Medicare, and other similar programs, it inadvertently harms other components of the economy such as business. Plainly, what the government is doing in this case is to make the cost of money more expensive so that there will be more buyer of its promissory notes or bonds. When cost of money becomes high, it will precipitate a vicious cycle in the economy. If we may recall the recent crisis both in Asia July of 1997 and United States in 2009, interest rates became so high that nobody can afford to loan it or banks were just hesitant to lend money due to the high prevailing interest rates thinking that they will not be repaid or that borrowers will default on it. So when interest rates or cost of money is high, business will freeze their expansion programs or whatever projects they have on the table. This will result in the freeze hiring of additional workers, business becoming less competitive resulting in the over-all contraction of the economy. So while there will be money that will be raised for financing the government social programs such as Social Security, Medicare, etch, it will eventually back fire in the future. Not only that the economy will contract, but there will also be lesser jobs available. Business will implement cost-saving measures and this will precipitate a recession as business are interconnected, one supplies the other or dependent with the other. When there are lesser jobs available or when companies are refusing to give its employee a salary raise, there will be less money available in the pockets of the consumer. When there is less money in the pockets of the consumer, they will tend to spend less. When there is less spending in the economy, there will be less incentive for the industry to produce. For one man’s spending is another man’
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