The Problem of the UK Budget Deficit - Coursework Example

UK Budget Deficit and Section # of UK Budget Deficit A budget deficit occurs when the actual or expected expenditures are more than the actual or expected revenues for a particular economy. An accumulation of the government deficits for a country over a number of periods eventually become government debt i.e. negative government savings. This deficit needs to be financed or funded by some sources which are often in the form of increase in the national debt via public or international borrowing. However, this borrowing increases the amount of taxes to be paid because the borrowing is not only to be repaid in principal but interests are also to be paid. The government debt increases due to budget deficits do no good but instead create complex problems for the economy and it drags the economy further away from growth. This is especially in the case of under developed economies as they are worse-off by such a situation. On the other hand, developed countries do have a cushion against such problems and endure the effects by strictly controlling the inflation through monetary policy. In case of developing economies, they have lesser reserves to back their position, while being more productive they still run continuous deficits (Charles, 1995). This invokes further activity, owing to the fact that the economy is below its potential output but usually is not managed adequately and thus results in demand pull or cost push inflation in different circumstances and hence these developing countries are seldom able to reap the benefits of their economic activity. Historic Overview The budget deficits are rooted from the time of the great depression of 1930s which was witnessed by and had strong influence on many economies worldwide before the Second World War though there were numerous reasons for the Great Depression beginning in 1929, including not only the structural weaknesses but also a series of certain other events. The declining demand in the economy laid down pressures on government and whilst they had to manage the decline in economic activity, the government expenditures eventually increased to accommodate these problems thus putting burdens over the budgets and eventually running deficits (Bernanke, 2007). Another reason stated had been the decline in international trade thus affecting many countries of the world whose economy depended on the international transactions. As stated by one of the famous analysts, the chain of events proceeded as follows (Fisher, 1933): The quick liquidation of debts and the aggressive selling out of anxiety The tight monetary policy of contracting the money supply while loans were being paid off A steep decline in the prices of different assets and commodities Fall in the shareholder value and correspondingly the overall worth of different companies expecting to go bankrupt Decline in profit margins Decline in real economic activity and hence total Output, international trade and employment levels Loss of confidence from the investor point of view and their resistant behaviour towards new investments Thus when the free hand didn’t work out, government started to play a pivotal role in the economic activity for the country and economies started to kick off guided by Keynesian approach. The budget deficits were seen as a chance to improve and enhance productivity. Recessions were viewed as part and parcel of the economic environment and often therefore were inevitable. In fact, they were seen as contributors to the correction and adjustment of all possible issues and gaps in certain economies correcting for the surpluses of the artificial economic booms, extracting the artificial effects of bubble from financial systems and restoring the energetic spirit and growth rates towards economic surpluses. But soon after the economies had regained or some developing economies were still trying to come back on the track, the oil crisis led to an economic recession. Since most of the world economies were dependent on oil for many obvious reasons, this impacted heavily and a number of economies ran into budget deficits due to heavy oil bills while the complementary inflation had created obstacles in the economic activity making their budget deficits larger. Budget deficits have always been a acute problem as evident by the two extreme examples of the 20th century. Currently the budget deficits being in place on the accounts of major developed economies of the world such as USA and the UK are just the beginning and can potentially cause much larger problems for the world economy as a whole. How to Overcome the Deficit? The current economic crisis has been mostly inflicted by the excess credit creation and compounding of debt over debt. The economic bubble of construction and artificial creation of demand was not backed up adequately by the available funds in the global economy and thus when the time came; there was a humungous amount of surplus supply in markets which left the construction and debt powered consumption worse off. Together, well over $500 billion in annual demand only from the construction sector have been lost. In addition, the loss of the temporary and artificial wealth that was created by the economic bubble has lead to fall in consumption levels leading to the loss of an additional $500 billion a year in annual demand in the case of USA. Given that this situation is not managed properly, it can lead to much larger spirals of deficits that will be a suicide for the major economies of the world such as the US and the UK for their consumption rates are deemed to be the highest in the world. For this purpose the governments should stimulate demand by temporarily increasing it’s spending towards consumer goods in majority and capital goods (to keep up with the capital formation ratio) rather than wasting trillions of cash into useless wars. This increased government spending might burden the balance of payments and increase the budget deficit for a moderate number of years, however, it is expected the that routing the funds of government spending towards the right directions of the economic activity will eventually start decreasing the gap between the expenditure and the income thus turning the deficit in to a huge budget surplus in five to ten years. The government spending shouldn’t be attempted to be recovered from high taxation otherwise it will have negative effects on the economic growth. Rather running a short term foreign borrowing to fund the budget deficit and induce more demand via government expenditure will eventually bring the economy of the countries such as UK and USA back on track and they will quickly be near to full employment or steady state. Time plays an important role in the macroeconomic policy implementation. Governments and/or policy makers have to consider several factors such as the political and socio-economic scenario of the country and have to consider the reservations of different regulatory authorities. Every such formality entails further time lags and this can become a potential hurdle for effective implementation of Policy. The time to recognize the fact that there is actually a problem is the starting point. For example, recession in a couple of consecutive periods (quarters, for example) with negative real growth in the real GDP takes about months to be recognized and documented before it is brought in front of the policy makers. Then the by the time the policy makers start working on it and the administrative formalities that are involved, for example, the signing of the final proposal by the parliament and all concerned authorities entails further delay, let alone the kick starting the implementation. Thus by the time we start with the implementation of the policy, the time it takes in its implementation to effect the economy; it does becomes so late that most of the factors have been corrected automatically by the invisible hand and the economy might have self-corrected to some extent or to an extent where the implementation of the target fiscal or monetary policy might actually de-stabilize the economy and make the condition worse-off. Timing, therefore in the identification, formulation and implementation of the policies and corrective measures taken to reduce or overcome the budget deficits are an important factor while considering solutions to reducing and controlling the budget deficit problem. Conclusion Budget deficit can be helpful for underdeveloped economies for nurturing higher productivity and increasing employment levels. However, it is a threat for country if it persists for a long period of time because the accumulation and compounded effect of a budget deficit eventually becomes a burden on the economy. Despite the financial crunch that the world had recently faced, the reality is that the governments of the developed economies have been unable to route the increased government expenditures into the right direction (Baker, 2010). Had the cash been invested into boosting real economic activity than wasting it into wars, we could have avoided the crisis. The problem still persists that we have an unemployment crisis today, not a budget deficit crisis. If this unemployment is avoided by the corporations worldwide by any strict government regulations, the demand will automatically be there and hence the budget deficits will vanish yielding economic growth and increases in output and resulting into budget surpluses in the case of economies such as UK and USA. References Abel, A. and Bernanke, S. B. 2007, Macroeconomics, 7th ed: Prentice Hall. Baker Dean 2010, The Budget Deficit Scare Story and the Great Recession: Center for Economic and Policy Research. Fisher Irving (1933) The Debt-deflation Theory: Federal Reserve Bank of St Louis. Michael Burda and Charles Wyplosz (1995), European Macroeconomics, 2nd ed: Oxford University Press Read More