Saturday, December 31, 2011

Spend Your Vote Wisely

Current elections in America allow new government to enact short or long term fiscal policies to fix the budget in a contracting economy.  Politicians are tempted to run budget deficits instead of surpluses because it allows them to cater to voters, either by cutting taxes without cutting spending or increasing spending without increasing taxes.  In 2002, France and Germany raised taxes and cut spending to lower their budget deficits which were in excess of 3% of GDP.  The debt to GDP ratio helps assess the ability of the government to pay it's debt.

Typically, American politicians don't believe government should be forced to run a balanced budget every year because it undermines the role of taxes and transfers as automatic stabilizers.  When tax revenue falls, transfers rise so when the economy contracts it helps limit the size of recessions.  However, falling tax and rising transfer payments push a budget toward a deficit.   In a balanced budget, government contractionary fiscal policy deepens recessions.

A problem with rising government debt is that it crowds out private investment spending, therefore increasing interest rates and deceasing the long run rate of growth.  Also the deficits today increase the governments debts putting a financial burden on the future budgets.  Interest payments on accumulated debt can be substantial.

When household credit card bills get out of control from the interest payments, it often results in bankruptcy.  When a government goes bankrupt it has the option to default on it's loans.  Countries that default have difficulty getting loans because of their poor track record with their financial responsibilities.  Argentina defaulted on their loans in 2001 causing a crisis in their banking system which led to a very deep recession.  Governments try to avoid default by cutting spending or raising taxes but both choices are politically unpopular.  Their currency has also been devalued by their economic difficulties.  Hopefully, American's politicians learn from other countries mistakes by choosing the long term economic solution for their country above their own career interests.


Deficit: the difference between the amount of money spent and the amount received in a year.  e.g. the US budget deficit in fiscal 2011 was $1,302,000,000

Debt: the sum of money owed at a particular point in time. e.g. US public debt at the end of fiscal 2011 was $15,158,000,000,000.



Krugman and Wells, (2008) Macroeconomics Second Edition, Worth Publishers. 

The US Debt Clock. http://www.usdebtclock.org

Center on Budget and Policy Priorities. http://www.cbpp.org/cms/

US Department of the Treasury. https://www.pay.gov/paygov/homepage.html