US rising debt level and current economic problems - Essay Example

? US Rising Debt Level and Current Economic Problems A budget deficit exists where the total government expenditureexceeds the revenue of the government. Government deficit means that the excess money needed to finance the government budget will have to be borrowed from other countries or be financed from donations (Hubbard & O'Brien 2007). In the United States, the soaring budget deficit has resulted in an increase in the overall government debt. Budget deficit is expressed as a percentage of GDP. There are various reasons for having a budget deficit. According to the forecast of the organisation for economic cooperation and development (2011), the budget deficit for US is likely to increase to 10% of the GDP. This projection means that the US government must formulate ways of arresting the looming economic crises as a result of the increasing deficits. The main reason why the public debt in America would increase is the need for the government to increase job opportunities by stimulating demand (Saad 2011). When a government intends to create more jobs, it will increase the level of demand by increasing its public expenditure and reducing the level of taxation. This had made the Obama’s government increase the level of public debt. At the same time, the 2008 economic recession could also be a reason for the increased budget deficit. After a recession, the economy of a country needs to be stimulated to increase the level of demand and to create more economic activities. This made the US government increased their level of budget deficit to increase the rate of recovery of the domestic economy (Amadeo 2011). The increased expenditure from external borrowing accompanied by a decline in the level of taxation must result in an increase in the level of public debt. If not closely monitored, the increased public expenditure will result in increasing level of inflation making prices of goods soar in the market. The increased cost in recapitalization and acquisition of financial institutions as well made the public deficit soar (Turner 2008). One of the causes of the economic recession was failure by the financial institutions to act decisively to rescue the depreciation in the economy. The failure by the credit rating agencies to give true credit risks made banks increase their mortgage loans that in the long run led to the recession. The US government as a result of this ventured into takeover of some banks which therefore meant increase in government spending making the economy experience a rising level of deficit (Saad 2011). The increases government spending accompanied by the declining tax rates was bound to increase the level of debt and this makes the projections of OCED realistic and important for government formulation. It must also be noted that the increasing deficit has made the democrats and republicans have clashes on the measures that the government should undertake to help reduce the level of deficit and the general debt level (Saad 2011). The two parties have agreed collectively on the short term measures of a cut in the government spending but have failed to agree on which areas that the governments should reduce spending. They also have different thoughts on the long term remedial. To correct the economic problems in the economy, the government can pursue a significant reduction in the deficit level. The US government through such a move would be in a position to reduce their increasing debt level and at the same time solve other economic challenges. A reduction in the level of budget deficit can be made for various purposes; the first reason for a reduced budget deficit would be to help reduce the level of government debt (International Monetary Fund 2010). For instance, the Obama administration projects that through the reduction in the government deficit for a decade would make the government solve the high level of debt (OECD 2011). Another reason for cutting the level of government deficit would be to reduce the level of inflation by reducing the demand level. A high level in demand for goods and services because of increased government and public spending makes the prices soar (Hubbard & O'Brien 2007). The government by reducing the level of deficit would help reduce the level of demand hence reduces the inflation problem. On the contrary, reducing the level of deficit can slow down the rate of economic growth by declining the level of demand. A reduction in the level of spending leads to reduced employment opportunity and this may make the level of unemployment increase. In a bid to reduce the budget deficit, economic planners must consider the impact of their action on the employment and economic growth. Moreover, a reduced budget deficit through an increase in taxation is also harmful to the economy. By increasing the tax revenue, the government will reduce their level of borrowing, as an increased proportion of the budged can be self-financed (Hubbard & O'Brien 2007). Increased tax level would discourage business and demoralizes workers because of the declining income. When this occurs, the aggregate supply would be reduced and corresponding decline in demand can cause an economic recession. This can reduce efficiency and output. Economic trade-off are mandatory for plausible solutions of economic problems. Keynesian economics has become a backbone in today’s economic policies. Keynes argued that the role of the government in taxation and through her spending will regulate the economic performance and should be used to control economic performance. In the US, the government formulated the American Recovery and investment Act of 2009 that was aimed at stirring economic growth after the recession. Keynes asserts that the increase in government spending after a recession can help in jumpstarting the economy and help reduce the unemployment level by increasing the level of aggregate demand. This increased expenditure should further be directed in sectors of the economy that determines greatly the economic output to ensure much efficiency. Secondly, the government can develop tax structures that would ensure that the economy is stimulated for growth purposes (Amadeo 2011). The federal government reduced the rate of tax on income to increase the disposable income, which thereafter led to a surge in the level of demand. This Keynesian economics means that a reduction in taxes would make the economy increase the production to satisfy the increased demand thereby increasing employment opportunities. Contrary to the belief that the government can stimulate the growth of its economy through the fiscal policies, the Keynes economics has been criticized that the reduction in taxes would increase the level of public debt and this would translate into increased inflation. At the same time, the government may fail to undertake its projects if their deficit is not completely financed. This therefore makes a reduction in taxes inappropriate in stimulating economic growth. Obama’s tax cut policy has been blamed for the increased US debt (Amadeo 2011). At the same time, through taxation the government will simply engage in crowding out of investment from the public. There will be no real impact on the economy as what will take place will be the transfer of individual expenditure or government expenditure hence no different economic impact (International Monetary Fund, 2010). The crowding out effect has been cited as a cause of reduced level of investment in instances that the government has increased its taxes. The level of demand would be reduced forcing the production level to decline hence a reduction in unemployment rate. The credit crunch of 2007 is truly a cause to the current problems that have faced UK and US. Most if not all the measures taken by the two governments is because of the 2008 recession that was because of the faulty credit rating in the American market. The housing bubble caused the recession where the banks extended loans to mortgagers with poor credit ratings after failure by the rating agencies to use the correct models in determining the worth of the borrowers (Turner 2008). The housing bubble led to the shocks in the stock markets forcing investors to withdraw their investments and lead to the declining economic performance. The role of financial institutions in the predication and stabilization of an economy is fundamental and negligence on the execution of their roles will lead to poor economic trends. The US for instance, after the 2008 housing bubble was characterized by poor stock market results. Collapse of Lehman brothers is the biggest bankruptcy ever with the collapse causing shock in the capital markets (Turner 2008). The subprime mortgage crisis led to the decline in the prices of housing forcing Lehman brothers dispose houses worth $6billion at lower prices. The large borrowing made the lenders incur huge losses, as there was failure in the repayment of the loans. The extending of the loan to lowly rated borrowers also made the financial marker experience a financial shock (Turner 2008). This spread across other financial markets causing recession. In conclusion, the role of the government in controlling and determining the economic performance is indispensable. The government agencies and institutions charged with the duty of regulating the economic trends must remain vigilant to ensure that the policies adopted promote economic development. The subprime mortgage crisis was because of negligence of the Fed. It is therefore clear that the debt control measures and soundness of financial markets should be upheld to reduce economic risks. List of References Amadeo, K 2011, The U.S. National Debt and How It Got So Big. Retrieved from http://useconomy.about.com/od/fiscalpolicy/p/US_Debt.htm Hubbard, RG & O'Brien, AP 2007, Economics,Pearson Prentice Hall. International Monetary Fund 2010 Finance & Developmen, International Monetary Fund Whasington DC. OECD 2011, United States - Economic forecast summary (November 2011). Saad, L 2011,U.S. Debt Ceiling Increase Remains Unpopular With Americans, Gallup . Turner, G 2008, The credit crunch: housing bubbles, globalisation and the worldwide economic crisis, Pluto Press. Read More