Question

What is the economic impact of a federal budget deficit? Describe the effect of debt financing accomplished by a sale of bonds to the general public.

Answer 1

When spending exceeds income, there is a budget deficit. The term applies to states, while deficits may be managed by individuals, corporations and other organizations. It is necessary to pay a deficit. If it is not, it will create debt. The surplus of each year contributes to the debt. As the debt increases, the deficit increases in two ways. First, it is necessary to pay the interest on the debt each year. This, while not providing any benefits, increases spending. Second, higher levels of debt can make raising funds more difficult. Creditors are worried about the willingness of the lender to pay off the debt. They demand higher interest rates when this happens to provide a higher return on this higher risk.

For most companies, chronic deficits are subject to immediate fines. If this is performed by an individual or family, their creditors are called. A credit score drops as the bills go unpaid. It increases the cost of new credit. They can finally declare bankruptcy. The same applies to companies with continuing deficits in the budget. Our ratings for bonds are through. We should charge higher interest rates when that happens to get any loans at all. These are referred to as junk bonds.

There's a different government. They receive tax revenue. Their expenses benefit the tax-paying people. With the provision of services, government leaders retain popular support. They will spend as much as possible if they want to continue to be elected. Most voters are not concerned about the debt impact. As a result, U.S. debt has increased deficit spending to unsustainable levels. The World Bank says this tipping point is when the debt ratio of a nation to gross domestic product is 77% or higher.

Government borrowing is another fiscal method by which community savings for economic development can be mobilized Governments in developing economies turn to lending to fund economic development schemes. It becomes important to have government or what is often called public borrowing because taxation alone can not provide sufficient funds for economic development. In fact, excessive taxation has an adverse effect on private savings and investment.

The government issues bonds under debt-financing of fiscal deficit and borrowing and sells them on the market. Generally speaking, the sale to the public of interest-bearing securities is indirect by financial intermediaries such as banks. Banks purchase government-floated bonds with the public's currency deposits. Therefore, budget deficit debt financing is also known as budget deficit bond financing. The government is able to expand its spending with the borrowed money in this way, but at the same time it adds to the public debt that has both short-term and long-term consequences. It can also be noted that when taxes are reduced, budget deficit also occurs, keeping government spending constant.

It is also possible to finance this type of budget deficit by incurring debt by selling bonds to banks or the public. In addition to paying interest on borrowed funds on an annual basis, the government must also pay back the principal amount borrowed for which it may in future levy higher taxes.