Public sector finances

Budget deficit

When public expenditure is greater than tax revenue

Types of budget deficits

• Cyclical deficits

• Structural deficits

Budget deficit

When public expenditure is greater than tax revenue

Types of budget deficits

• Cyclical deficits

• Structural deficits

Economic boom

A period of positiveeconomic growth

Economic bust

A period of negative economic growth

Business cycle

Fluctuations in the level of real GDP over time

Recession

Six consecutive months of negative economic growth

How does high levels of unemployment worsen the budget deficit?

• Fewer people working meaning the government has to spend mire on benefit schemes for the unemployed

• Ultimately decreases the amount of tax revenue the government has

What happens in a boom?

• Increased derived demand for labour

• Increased tax revenue

• Decreased government spending on benefits

• Improvement of the budget deficit

What happens in a recession?

• Decreased derived demand for labour

• Increased unemployment

• Decreased income tax revenue

• Increased public expenditure on benefits and training

• Decreased tax revenue

• Worsening of the budget deficit

Cyclical deficit

A budget deficit that only occurs in recessions

Structural deficit

When a budget deficit occurs even during a boom (exists in every part of the business cycle)

Problems with structural deficits

• A country will be accumulating debt in every stage of the business cycle

Treasury bills

Government bonds

How can a government get out of a structural deficit?

• Contractionary fiscal policy

• Selling govt bonds (short term fix)

• Improve tax compliance

National debt

The total sum of past fiscal deficits accumulated by government borrowing over time

Why might national debt not be that deep?

Because it can be used to invest into the future which can later foster economic growth

How does a budget deficit/national debt impact interest rates?

• Demand for money increases due to the government demanding so much money

• This increases the price of money

• Interest rates rise significantly

How does a budget deficit/national debt impact financial crowding out?

• Higher interest rates

• Disincentivises private firms from borrowing money - they would have to pay more interest back on the loan

Financial crowding out

When the worsening of the budget deficit causes interest rates so high that it disincentivises private firms from borrowing money, reducing investment

How does a budget deficit/national debt impact future generation?

They will have to repay the massive amounts of national debt incurred by their predecessors through increasing taxes and cutting expenditure

• Increased financial burden

• Leaves future generations with lesser income and lower standards of living

OBR - Office for budget responsibility

Independent from the government and can’t be influenced by corrupt decisions

Role of the OBR

They write reports regarding possible irresponsible spending happening within the government to reach their set fiscal targets