Key Concepts of Economics Environment - Coursework Example

Economics Environment The term budget deficit in an economy simply implies that the public expenditure of the government exceeds the amount of revenue earning in a financial year. This is generally occurs in an economy when the government’s actual expenditure goes beyond its planned expenditure. A budget deficit situation in an economy also emerge when the government wants to opt for a deficit financing methodology to finance the public projects by increasing the amount of expenditure over the amount of tax collection. For implementing a budget deficit plan the government borrows money from the market by issuing Treasury bills and long term bonds of the government with a maturity period. The central bank of the economy takes its part for issuing such government debts by debt selling in the bond market and in the debt market. Generally the financial institutions of the economy buy such government bonds but the individual citizens of the nation are also allowed to buy the bonds and the national savings certificates. However, when the government caries forward a budget deficit plan regarding its public expanses for a very long time period, the total amount of deficit then called as government debt. In this situation some part of spending of the government used for reimbursement of such debts. (Budget Deficit, n.d.). A deficit financing through public borrowing generally leads to increase in aggregate demand in the economy and therefore stimulate the economic activities so as to increase the growth and level of employment in the economy. At the end of the Second World War Britain got relief from the huge deficits of the war. Government expenditure was mobilized to the other sectors of the economy. But with the rise of military expenditure in 1950 in Korea, the UK government had to take a deficit budgetary policy that led the amount of deficit to reach to almost 4 percent of GDP in 1953. With the entering in the period of cold war Britain took the policy of fiscal activism between 1950 and 1960. The amount of deficit fluctuated from 2 to 3 percent of GDP in almost every year up to 1967 when the deficit rouse again to 4 percent of the GDP. The government immediately took fiscal tightening measurements that ultimately resulted in surplus in 1969 and 1970. However, fluctuation inn deficit became very apparent after 1970 and in 1973 the deficit again came back to 4 percent of GDP. The situation further eroded when the deficit touched almost 7.3 percent in 1975 with the significant effect of the post war recession. This situation insisted the government to take the deficit reduction strategies for a long period of time and the Britain ultimately benefited with budgetary surpluses in 1988 and 1989. The UK started its journey of the decade of 90s with a rapid increase in public borrowing that turned surpluses of the recent previous years into deficits. In 1993 the amount of public sector net borrowings increased to 7.8 percent of GDP. The government had to decrease its borrowings in the subsequent years and in 1998 the UK was able to get back the surpluses. In 2000 the amount of surpluses became 2 percent of GDP, the amount that the UK had not been able to touch after 1940. All these statistical reality shows that since the post Second World War the UK government took expansionary fiscal policies with a budget defect mechanism in almost every year. The government engaged in borrowing in almost every year and repays its debts in only some few years. (Clark and Dilnot, 2002). However, with the appearance of the 21st century the story of Britain deficit budgeting changed dramatically. From 2002-03 till today the UK government is gradually facing huge increase in its budget deficit. The February 2010 net public borrowing of the government has became £12.4 billion from £ 8.8 billion in February 2009. Net public sector liability has climbed to 60.3 percent of GDP at the end of February 2010 from a level of 50.5 percent of GDP in the February 2009. (Monthly: £6.0bn budget deficit, March 29, 2010). The coming out of an increasing budget deficit in the 21st century is mainly for a weaker economy and the results of rising government expenses on the concerning sectors like education, health, transport, defense, etc. We have shown the increase in net government borrowing and the gross consolidated debt as a percentage of GDP over a period of 14 years (1994-95 to 2008-09) by the figure 1 and 2 respectively. Figure 1: Increase in net borrowing of the government over time Source: UK National Statistics  In figure 1, we have seen that there occurred a sharp decline in net borrowing of the government upto the end of 20th century. However, in the 21st century the trend of government borrowing is positive. Figure 2: Increase in government’s gross consolidated debt over time Source: UK National Statistics  In figure 2 we have seen that though the amount of the gross consolidated debt of the government has fallen up to 2001-02, but the debt trend of the government is significantly positive from the period of 2002-03 However, though it is generally thought that a deficit budgetary policy by increasing government expenditure in the public arena will help the economy to sustain its growth path and employment generation, there are some inherent disadvantages also lie under this policy. The first and primary effect is that a deficit budget financing lead to increase the debt burdens of the government and so the amount of annual interest payments. The related opportunity cost is very high as more public borrowings at present lead to higher tax payments by the future generation at the benefit of present generation. This guides to a fall in the working incentive in the economy. A deficit budget by cutting the level of tax increased aggregate demand, which in turn increase inflation in the economy. More public borrowings of the government imply more sales of government bond raising the level of interest rate, the price of such bonds. Increase in rate of interest results in fall of private expenditure in the economy. So, there is always a possibility that a crowding out effect will occur in the economy reducing the degree of the expansionary effect that was expected with a deficit budgetary finance. Regarding this issue of the huge budget deficit in UK, there emerges many critics of MR. Gordon Brown, the prime minister of UK. They have argued that Mr. Brown has lost his control over the budget deficit and the amount of tax revenues is very poor while the public sector expenditures are still high. Over the previous years MR. Brown’s reputation regarding his fiscal cautiousness has come under tremendous pressure. Keeping these criticisms and the concern over the amounting deficit in the government budget MR. Brown has recently states that his government would like to carry forward subsequent cuts in government debts to reduce the level of deficits. This statement of Mr. Brown has been truly reflected in the recent budget of UK that sufficiently tells that the government is now completely ready to reduce the enormous pressure of the huge budget deficit. Notwithstanding the difficulties in a deficit budgetary mechanism, one cannot neglect the fact that such policy measurement is beneficiary for generating employment and increasing economic growth, especially at the time of economic recession. Though Mr. Alistair Darling, Chancellor of the Exchequer of UK has taken an aggressive decision to trim down the government debt, he is also concerned about the fact that a high degree of debt reduction strategy may further lead the UK economy to fall in recession. However, a proper monetary mechanism can be seen as an alternative policy tool for strengthening the economic backbone of UK, particularly when the government is in a mood to cut debt subsequently. The government may increase the monetary base to influence the economy. An increase in money supply by reducing cash reserve ratios of the commercial bank may help to generate more liquidity in the economy. With the easing of getting loans, the private investor will be inclined to invest in the economy so as to increase the level of aggregate demand and employment. But there lies also a question mark on the strength of the monetary policy since there is always a fear of credit crunch as the UK economy has just come out from the recession. A credit crunch is an economic state which decreases the availability of loans. During a recessionary period the commercial banks do not want to lend money to avoid the credit risks of repayment of their lending amounts. The consumers as well as the corporations face this credit crunch problem as the banks may be less confident for lending considering the other market fluctuations, like the recent fluctuations of the real estate market. This type of collapse of market price is very much responsible to create a credit crunch problem in the economy. The banks may be worried over the solvency and debt repaying ability of the other banks as well. Emergence of a credit crunch problem in the economy will ultimately lead to an increase in the rate of interest guiding to fall in aggregate demand, level of output and employment. Therefore, the government should take the responsibility for improving the economic condition, especially when it just gets well from the great recessionary pressure. There is no doubt that to get relief from the burden of debt, government at present has to take a tight fiscal policy, but beside the government is also responsible to overlook the economy so that no credit crunch problem persists in the country so as to keep a steady momentum of growth in the UK economy. (What a Credit Crunch?, 2010). References: 1) “Budget Deficit” (n.d.), Economywatch, Stanley St Labs.Available at: http://www.economywatch.com/budget/important-concepts/deficit.html (accessed on April 11, 2010) 2) Clark, T and Dilnot, A (2002), “Measuring the UK Fiscal Stance since the Second World War”, IFS, pp 1-7.Available at: http://www.ifs.org.uk/bns/bn26.pdf (accessed on April 11, 2010) 3) “Monthly: £6.0bn budget deficit” (March 29, 2010), Public Sector, Office for National Statistics. Available at: http://www.statistics.gov.uk/cci/nugget.asp?id=206 (accessed on April 11, 2010) 4) “What a Credit Crunch?” (2010), wisegeek.Available at : http://www.wisegeek.com/what-a-credit-crunch.htm (accessed on April 11, 2010) Read More