Essay Example: Government Deficits Harmful to the Economy

In what ways are the government deficits harmful to the economy? The Bad The main worry about deficits is crowding out. Crowding in was Just described ? ?” it occurs when deficits cause output to go up and business confidence is increased. Crowding out comes about when deficit spending raises Interest rates. There Is a limited amount of funds available for investment, and when government competes with the private sector for a share of these funds to finance its deficit spending, it drives the cost of these funds ? ?” interest rates higher. The increase in the interest rates causes Investment to fall, and lower Investment translates Into lower output and lower economic growth. In Dalton, to the extent that the private sector Is more efficient than the public sector, crowding out, I. E. More government spending and less private investment, can result in a less efficient use of resources (though in the case of public goods government can be the more efficient provider, and hence It Is not always the case that efficiency falls).

Another worry about deficits is that they will be monitored leading to inflation. Debt integration occurs when the Fed prints new money and uses it to purchase government bonds help by the private sector. This removes debt from the private sector and replaces it with money, and if the money is used to purchase goods and services, as It’s likely to be, this can be inflationary (though when there is an excess supply of goods, as in a deep recession, inflation is unlikely to be a problem).

The ugly The worst outcome would be for the deficit to get so bad that the government chooses to default on debt payments (which could also lead to some other currency, r a basket of currencies, replacing the dollar as the vehicle and reserve currency). I don’t expect this to happen, particularly since we can always print money to pay off our debts.

But printing money to pay off debt could be highly inflationary, it could lead to high interest rates as foreigners refuse to lend to us for fear we’ll inflate the obligation away when It comes due, and the government could still choose to default If It Is the least costly option among bad alternatives. Thus, It needs to be mentioned as a possibility. The Showdown Which of these concerns Is most Important? Notice that In the short-run, the consequences of deficits are mostly positive when the economy Is In a recession.

Deficits allow us to stabilize the economy (though it’s important we pay the bills when times get better), deficit spending can stimulate investment through crowding in, and there’s little danger that the spending will drive up interest rates or be Inflationary due to the large amount of slack In the economy. FIFO employment deficits can lead to higher interest rates, crowding out, less investment, and slower growth. Inflation can also be a problem, and if the debt burden gets bad enough, outright default is a possibility.

That’s why economists who have supported the use of monetary and fiscal policy to ease the effects of the recession are recommending that we continue the stimulus for now, or at least that we don’t make things worse by reducing spending or raising taxes before the economy is on better footing. We do have a deficit problem, and it must be addressed over the medium and longer term in order to avoid the negative effects described above. But reducing the deficit before the economy is on solid footing can be counterproductive ? ?” it could slow the recovery or even cause a tieback.

If we are smart ? ?” if we continue to help the economy now and implement a credible deficit reduction strategy over the longer term ? ?” the good can triumph over the bad and the ugly. Unfortunately, the way things look presently, with the deficit hawks demanding immediate action to stave off invisible bond vigilantes, and the inflation hawks pushing for interest rate increases to keep the invisible inflation fairies at bay, there’s no guarantee that good will prevail. 2. You are hired as an economic adviser to a benevolent ruler of a small country.

The Euler asks your opinion if she should conduct discretionary monetary policy to improve the well-being of her citizens. Under what conditions would you advise her to actively intervene in the economy using discretionary monetary policy? A discretionary policy is supported because it allows policymakers to respond quickly to events. However, discretionary policy can be subject to dynamic inconsistency: a government may say it intends to raise interest rates indefinitely to bring inflation under control, but then relax its stance later.

This makes policy non-credible and ultimately ineffective. A rule-based policy can be more credible, because it is more transparent and easier to anticipate. Examples of rule-based policies are fixed exchange rates, interest rate rules, the stability and growth pact and the Golden Rule. Some policy rules can be imposed by external bodies, for instance the Exchange Rate Mechanism for currency. As a leading economist, the Malaysian government is looking to you for suggestions on how to handle these economic situations.

Explain in a short paragraph one action that you would suggest to Bank Engage Malaysia (monetary policy) and one action to he Federal government (fiscal policy) to help the economy “healthy’ again. Economic Scenario #1 : GAP is down for 3 consecutive quarters Unemployment is up ICP is stable According to several superficial criteria, prevarication in Malaysia made good progress, especially in terms of the government’s own declared objectives.

In terms of raising efficiency and productivity, it is generally agreed that the establishment of TV introduced some competition into the television broadcasting industry previously dominated by the government’s two channels. While prevarication undoubtedly reduces the role of the public sector in the economy, it is not clear whether this is supposed to be a desirable end in itself, or merely the means to an end.

If the former, then the policy is essentially either intended to aggrandize its politically influential beneficiaries, or clearly ideologically inspired, or else meant to please ideologically motivated governments and powerful international economic agencies (such as the World Bank, MIFF or Asian Development Bank) the Malaysian government seeks to find favor with. There is evidence that all here factors may be relevant in the Malaysian case.

Primary Objectives: The following are the primary objectives which have been defined in the raiment’s policy statement on Partially Sector Reform: * Improve the operational efficiency of enterprises that are currently in the Partially sector, and their contribution to the national economy; * Reduce the burden of Partially enterprises on the Government budget; * Expand the role of the private sector in the economy, permitting the Government to concentrate public resources on its role as provider of basic public services, including health, education and social infrastructure; and * Encourage wider participation by the people in the ownership and management of business. In pursuing these primary objectives the CHIC aims to: * Transform, through centralization, restructuring and divestiture, the performance of most significant enterprises in the Partially Sector; and * Ensure liquidation of all non-viable Partially enterprises as soon as possible.

Secondary Objectives: In so far as their pursuit is consistent with the primary objectives, the CHIC intends to ensure that divestiture meets the following secondary objectives: * to create a more arrest-oriented economy; * to secure enhanced assess to foreign markets, to capital and to technology; * to promote the development of the capital market; and * to preserve the goal of self-reliance.