‘It is essential for the government to cut public spending and raise taxes to reduce the public sector deficit’ discuss

20 marks

Introduction

Define public sector deficit (budget deficit) and make the link to debt. Identify the fact that high levels of deficits and debt can create problems/advantages for an economy.

Paragraph 1: Intergenerational inequity and opportunity cost

Analysis: High debt = High interest repayments, which means less funds available for public services. Creating an increased burden for future generations in the form of High tax/reduced public services. Aditionally, high debt may reduce gov ability to respond to future shocks, resulting in economic vulnerability.

Evaluation: Reducing the deficit is not always essential immediatley, if borrowing funds productive investment, LR growth may improve and GDP-debt ratios improve.

Paragraph 2: Crowding out

Define what crowding out is (As the government borrows more to fund spending, demand for loanable funds rises, pushing up interest rates. Higher borrowing costs make it more expensive for businesses and consumers to invest)

Analysis: High deficit requires high borrowing, increased demand for loanable finds pushes up the interest rates. Higher borrowing costs, reduced private investment- lower AD and restricts LRAS growth. Long term productivity and competitiveness fall, harming furture GDP growth.

Evaluation: Keynesians would argue that in a recession, there is no crowding out because the government is merely spending unused resoruces e.g. UK 2009-13, decreased bond yields and no one wanting to invest.

Paragraph 3: Credit down grades

Explain credit ratings (letter-based rankings issued by agencies that assess the ability and willingness of a company or government to repay its debts on time.)

Analysis: Large persisted deficits can lead to credit rating agencies to question the sustainability of gov finances. A downgrade increases borrowing costs due to a lack of confidence, worsening the defict and investor confidence.

Evaluation: Austerity has been shown not to work e.g. countries with high debt maintain low yields due to institutinal/market strength.

Conclusion

Decreasing deficits can be essential in the LR to limit interest repayments, protect future generations and support fiscal credibility. However, cuts and tax rises are not always effective and essential especially in recessions or when borrowing finances investment