Question

In this final Written Assignment, you are asked to consider several aspects of international government finance. When governments spend more than they collect in taxes, they can borrow money to cover the shortfall. First, what makes almost all government politicians everywhere in the world continue to spend more than is collected in taxes? Then, briefly explain why a government would continue to borrow if it knew it could never pay back all of the loans, including interest. And finally, borrowing requires people to loan the money to the government (by buying government bonds). So why would international bond buyers be willing to purchase government bonds from Greece, Spain, Portugal, and Italy when there appears to be some risk that those governments will not be able to pay back those loans?

Answer 1

The government spending is much more than the taxes that it collects due to the responsibility of the government to meet the needs of Defence, social security and health programs. The government also needs to spend on infrastructure and education of the economy and mere tax collection is not sufficient to meet these needs.

Government borrows so that it can meet its expenditures without increasing the taxes in the economy. There may be different reasons for the government borrowing. The tax revenues may be less than what was predicted. There may be unexpected recession and hence higher expenditure on unemployment. The government may be required to invest in public sector Investments. All these expenditures which the government cannot avoid and hence the only way out is to borrow money.

Investors may borrow money from Greece, Spain, Portugal and Italy in spite of the risk of default due to the high yields offered by these countries. Due to the high risk involved the investors get a high returns which attracts them towards such Investments.