Controversial Debt Stabilization - Essay Example

Debt stabilization is controversial. One view is that it requires running balanced budgets irrespective of the possible cyclical implications. Another view is that it is far better to use fiscal policy to support rapid growth. Evaluate these arguments. Contents Contents 1 Introduction 3 Discussion 3 Balanced budget 3 Fiscal policies 6 Conclusion 7 References 8 Introduction The process of debt stabilization can be done by two different ways- either by using a balance budget process or through the implementation of the fiscal policies. The debt stabilization process has become a key economic issue across many developed and developing countries. The governments of these countries use monetary and fiscal policies in order to stabilize the debts. There are major links between the monetary authorities and the fiscal authorities in the process of stabilization of debt. After the 1980s, many developing as well as emerging economies faced the problem of increasing debts for the government and issues in stabilizing these debts. Therefore, debt stabilization became a critical issue for consideration in the policy discussion and formulation processes across different economies. The debt target set in the Maastricht Treaty has also popularized the issue of debt stabilization. Also, the OECD has expressed an increasing concern related to the fiscal stance of the member countries of OECD related to implementing policies for effective debt stabilization. The conflicts between the use of monetary and fiscal authorities have been prevalent in the recent years related to whether the fiscal policies or the monetary instruments like balanced budgets are more effective for the stabilization of debt. Discussion Balanced budget Balanced budgets used by the government are budgets in which there are no budget surpluses or deficit i.e. the revenues are equal to the expenditures. The budget may have a surplus but does not have a deficit in any situation. Generally a balanced budget is of two types: cyclically balanced budget and annually balanced budget. A cyclically balanced budget is balanced over a year and shows surplus in the economy. A cyclically balanced budget on the other hand is spread over an entire economic cycle and demonstrates surplus during the boom period and deficit during the trough periods of the business cycle. Balanced budgets can help in stabilizing the debts and the economy as a whole. Budget surpluses and budget deficits play major roles in debt stabilization. The projection of the monetary and fiscal policies implemented in several countries in order to stabilize the debt levels indicate that the debt stabilization done by the companies by implementing the fiscal policies would be higher only by 30% of the GDP as compared to the present levels (Vince and Siddiki, 2009, pp.1155-1164). It is indicated that despite the cyclical fallouts, the use of balanced budgets can be advantageous for debt stabilization. When the economy of a country experiences the trough phase of a business cycle or enters the recession phase, the tax amounts fall as a con sequence of the decreasing employment and income levels. Consequently, the spending of the government increase as the unemployed people is given unemployment benefits and other benefits like the welfare payments (Mankiw, 2013, p.782). On the other hand, when an economy experiences a high level of inflation and is in an expansionary process, a balanced budget is useful in stabilizing the economy. In this scenario, the taxes increase as a consequence of the increase in income levels and employment levels. Therefore, the government reduces its expenditures because the requirement of unemployment compensation benefits and other types of transfer payments are not there. These changes impact the aggregate demand and consumption levels and the surplus ultimately works towards stabilize the debt levels in the economy during the inflationary times. The objective of implementing a balanced budget is to reduce the effects of an unsustainable debt structure which may be produced in the economy due to more deficit spending. The annually balanced budget may act as a pro cyclical policy that can cause more depression in the business cycle. The cyclically balanced budget would allow for the implementation of specific debt stabilization approaches through the various phases of a business cycle. The deficits may exceed the surplus levels and cause an increase in the debt levels instead of stabilizing the debts. It can be argued that an annual balanced budget can create more disadvantages than advantages with respect to debt stabilization. The cyclical implications of the use of a balanced budget to stabilize the debts may actually cause more misbalances and destabilization of the economy (Gottfries, 2013, p.90). This is because, during the recession phases, the expenditures generally rise while the revenues show a downward trend. This creates a deficit in the economy. If the government wants to balance the budget, it becomes necessary to collect more taxes to increase the revenue and decrease the expenditures. Both the processes of increasing revenues and decreasing expenditures may lead to a decrease in the disposable income. This in turn will lead to the reduction in the levels of aggregate demand and consumption. All these factors would cause the recession phase to become worse in magnitude and time. In the inflationary period, the economy is characterized by a rise in the revenues and fall in the expenditures. These changes may result in the creation of surplus in the economy. If the government wants to reduce the surplus in this case, it would have to cut down on the tax collection and increase the expenditure levels. These actions would lead to an increase in the disposable incomes and may cause more imbalances in the economy (Burda and Wyplosz, 2009, pp.119-120). Therefore, it may be considered that the use of budget balances may not be the most appropriate mechanism of debt stabilization. Fiscal policies Fiscal policy is one of the most important factors to maintain the stability for growth in macroeconomic environment. It also helps in correcting market failures as well as for intra and intergenerational transfers of wealth. Often Governments at their disposal have 25 and 40 per cent of national income for spending. The composition of government spending matters for both the quality and pace of growth. However government spending on public and private goods is different. Public goods relate to the expenditures in the private economy that complement rather than substitute for the production activities. Public goods are the expenditure targeted by the government to mitigate certain market failures. These expenditures also relate to in kind or cash transfer for backward households, public infrastructure and so on. The non-social subsidies which comprises of corporate subsidies credit guarantees, credit subsidies etc. are the expenditure on the private goods that substitute rather than complement the production by the private sector. Fiscal policy is thus entrenched deeply in political economy with tax exemptions and subsidies. Government spending on public goods is associated with more of poverty reduction and stabilized economic growth compared to expenditures in subsidies and private goods that distorts markets. Thus fiscal policy is very important in the use of government spending and taxation to influence the economy. Governments influence the economy by changing the type and level of taxes, the composition of spending, and the degree and the form of borrowing. Keeping the whole government expenditure constant it is always beneficial to shift the expenditure on private goods to public goods which in turn enable more of economic growth and stability (Jones, 2011, p.189). Government influence the way resources are used in the economy either directly or indirectly. The GDP (gross domestic product) according to the expenditures is calculated by the formula GDP= C+I+G+NX where C stands for the private consumption, G stands for the purchase of goods and services by the Government, I stands for the private investment, NX stands for the net exports. This shows that government controls GDP through controlling the factor G and influencing factors C, I, NX through changes in taxes, spending, and transfers. Fiscal policy increases the aggregate demand through an increase in government spending. Fiscal policies vary for short and long terms. For short term it focuses on the macroeconomic stabilization through cutting taxes or expands spending to support an ailing economy or to slash down the spending and increase taxes in order to combat the rise in inflation (Perry, Serven and Suescun, 2008, pp. 189-191). For longer term the focus is on reduce poverty and sustainable growth with actions to improve infrastructure or education. Ultimately the economic growth depends on the fiscal place for new tax cuts or spending initiatives. Fiscal policy is the way that the tax money is used by the government to influence the economy. Hence it is very important and supports rapid growth of economy by its ability to affect the GDP (gross domestic product) by having a control on how much output is generated. Conclusion The balanced budgets have been used by many economies to offset the effects of inflation and recession on the debt levels. The annual and the cyclical balanced budgets are used as effective tools to ensure debt stabilization in the countries across the globe. But the secondary effects of the balanced budgets have clearly identified the use of fiscal policies as a more preferred policy for debt stabilization. But many economists argue that a balanced budget constraint may be effective in controlling the spending levels and create a political structure that would undermine the usefulness of fiscal policies with respect to debt stabilization. The use of fiscal policies or balanced budgets for stabilizing the debt levels may depend on the economic structure and the economic constraints pertaining to specific countries. References Burda, M. & Wyplosz, C. 2009. Macroeconomics: A European Text. Oxford: Oxford University Press. Gottfries, N. 2013. Macroeconomics. London: Palgrave Macmillan. Jones, C. 2011. Macroeconomics. London: Routledge. Mankiw, N. G. 2013. Macroeconomics. Stamford: Cengage Learning. Perry, G., Serven, L. and Suescun, R. 2008. Fiscal Policy, Stabilization, and Growth. Washington DC: World Bank Publications. Vince, D. & Siddiki, J. U. 2009. The twin deficits in OECD countries: integration analysis with regime shifts. Applied Economics Letters. Vol.16 (11), pp. 1155-1164.  Read More