{"id":7242,"date":"2017-10-19T09:15:32","date_gmt":"2017-10-19T07:15:32","guid":{"rendered":"https:\/\/altax.al\/is-a-large-deficit-harmful-to-the-economy\/"},"modified":"2021-11-19T16:24:07","modified_gmt":"2021-11-19T15:24:07","slug":"is-a-large-deficit-harmful-to-the-economy","status":"publish","type":"post","link":"https:\/\/altax.al\/en\/is-a-large-deficit-harmful-to-the-economy\/","title":{"rendered":"Is a Large Deficit Harmful to the Economy?"},"content":{"rendered":"<p style=\"text-align: justify;\">When the economy is at full employment (meaning practically all labor and capital resources are\u00a0in use), government budget deficits crowd out private investment spending in the standard<span style=\"font-family: 'Calibri',sans-serif;\">\u00a0<\/span>macroeconomic model. Setting aside foreign capital flows for the moment, borrowing can only be<span style=\"font-family: 'Calibri',sans-serif;\">\u00a0<\/span>financed through saving, and government borrowing competes with business borrowing for the\u00a0same pool of national saving. By increasing the demands on that pool of national saving,\u00a0government borrowing pushes up the cost of all borrowing through higher interest rates, causing\u00a0businesses to finance less capital spending than they otherwise would.<\/p>\n<p><!--more--><\/p>\n<p style=\"text-align: justify;\">Business borrowing\u00a0finances capital spending on plant and equipment, and lower capital spending results in lower\u00a0potential gross domestic product, and hence lower future national income, than would otherwise\u00a0occur.<\/p>\n<p style=\"text-align: justify;\">In the current context, the economy is not at or near full employment. In this context, government\u00a0deficits are unlikely to crowd out private business borrowing. This greatly reduced the potential for large\u00a0government deficits to crowd out private investment spending. As discussed above, low interest\u00a0rates support the view that the deficit is currently causing little crowding out to occur. In this case,\u00a0the decline in aggregate spending caused by falling investment spending can be offset, at least in\u00a0part, by the rise in (deficit-financed) government spending, which directly increases GDP. Most\u00a0economic forecasters predict (me either) that the rise in the budget deficit will, on balance, raise GDP over\u00a0the next couple of years, despite a possible crowding out effect. Indeed, it is the increase in the deficit that is the primary reason that the stimulus package was projected to stimulate the\u00a0economy in standard macroeconomic models.<\/p>\n<p style=\"text-align: justify;\">With international capital mobility, borrowing can also be financed by foreign saving. In the\u00a0standard macroeconomic model with perfect capital mobility, the boost in aggregate spending\u00a0from the stimulus would cause the trade deficit to rise as foreign capital is attracted to higher\u00a0domestic interest rates. The availability of foreign credit would avoid the crowding out of\u00a0domestic capital investment. But the boost to aggregate spending from the budget deficit would\u00a0be negated by the higher trade deficit. Albania relies heavily on\u00a0foreign borrowing, and this is another reason that large budget deficits could be less effective at stimulating the economy. The lack of perfect capital mobility and large output gap in Albania\u00a0at present means that a larger trade deficit is unlikely to completely negate the stimulus as\u00a0theory would suggest, but it is likely to make it less effective at boosting aggregate spending.<\/p>\n<p style=\"text-align: justify;\">Since the decrease of economic growth\u00a0began in 2011, the trade deficit has fallen substantially, so the problem of crowding\u00a0out from the trade deficit does not seem significant at this time. It should also be noted that if\u00a0capital spending is financed by foreigners, the income generated by that capital will accrue to foreigners instead of Albanians.<\/p>\n<p style=\"text-align: justify;\">As the economy returns to full employment, large budget deficits will no longer provide any\u00a0stimulus to aggregate spending. At this point, crowding out will become a more serious concern\u00a0if the budget deficit is not reduced. By accounting identity, domestic investment must equal\u00a0national saving plus net borrowing from abroad. From 2000 to 2014, domestic investment\u00a0averaged about 7% of GDP. In\u00a0all these years there is deficit of budget\u00a0that did not increased national saving. The deficit was at\u00a05% of GDP from 2013 to 2014.\u00a0Despite the rise\u00a0in national saving these years, net borrowing\u00a0from abroad remained relatively steady because total investment spending fell to 12.4% of GDP.<\/p>\n<p style=\"text-align: justify;\">At that point, even if the deficit were to fall by half as a share of GDP, either private\u00a0saving would need to rise significantly above its average over the past ten years or net borrowing\u00a0from abroad would have to be significantly higher than the average of past 15 years. In other words,\u00a0even before the rise in the budget deficit, the combination of low rates of national saving and high\u00a0rates of borrowing from abroad to finance domestic investment spending was unsustainable in the\u00a0long run. If the budget deficit remains at elevated rates, national saving will be even lower,\u00a0requiring either lower rates of domestic investment or higher rates of borrowing from abroad.<\/p>\n<p style=\"text-align: justify;\">Another concern that has been raised is that large deficits will lead to high inflation. A significant\u00a0increase in inflation is ultimately a result of changes in the money supply, and the Bank of Albania\u00a0controls the money supply. Large\u00a0deficits would lead to higher inflation if the Bank of Albania\u00a0begins to finance unfunded government\u00a0operations by increasing the money supply.<\/p>\n<p style=\"text-align: justify;\">In order to avoid default, a central bank\u00a0might ultimately be forced to monetize the debt if private investors become unwilling to finance it\u00a0and the government refuses to raise taxes or cut spending. Investors may perceive this future\u00a0outcome and raise their inflationary expectations today. If investors anticipate that the debt will\u00a0be monetized, they will require higher interest rates to finance it in the meantime, so inflation will\u00a0ultimately be higher than if the deficit had been monetized from the outset.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>When the economy is at full employment (meaning practically all labor and capital resources are\u00a0in use), government budget deficits crowd out private investment spending in the standard\u00a0macroeconomic model. Setting aside [&hellip;]<\/p>\n","protected":false},"author":2,"featured_media":6316,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"inline_featured_image":false,"footnotes":""},"categories":[9756],"tags":[8253,8241,8485,8516,8563],"class_list":["post-7242","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-blog","tag-capital","tag-economy","tag-finance","tag-government","tag-inflation"],"featured_image_src":{"landsacpe":["https:\/\/altax.al\/wp-content\/uploads\/2017\/10\/deficit.jpg",400,371,false],"list":["https:\/\/altax.al\/wp-content\/uploads\/2017\/10\/deficit-400x348.jpg",400,348,true],"medium":["https:\/\/altax.al\/wp-content\/uploads\/2017\/10\/deficit-300x278.jpg",300,278,true],"full":["https:\/\/altax.al\/wp-content\/uploads\/2017\/10\/deficit.jpg",400,371,false]},"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.7 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Is a Large Deficit Harmful to the Economy? - ALTAX<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/altax.al\/en\/is-a-large-deficit-harmful-to-the-economy\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Is a Large Deficit Harmful to the Economy? - ALTAX\" \/>\n<meta property=\"og:description\" content=\"When the economy is at full employment (meaning practically all labor and capital resources are\u00a0in use), government budget deficits crowd out private investment spending in the standard\u00a0macroeconomic model. 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