The budget deficit as a percentage of GDP tends to rise during recessions, as indicated by the Bureau of Economic Analysis and the National Bureau of Economic Research.

The budget balance and business cycle have a constant relationship as it incorporates a recession that moves the total balance towards a deficit. However, the expansion moves it towards a surplus where the unemployment rate is a large contributing factor toward measuring the indicator of a business cycle. Therefore, it can be inferred that the higher the unemployment rate, the higher the budget deficit.

Through the multiplier effect, a lower interest rate will lead to greater investment spending, which will lead to higher real GDP, which will lead to more consumer spending, and so on.

As a result, as the number of money increases, the total quantity of goods and services required at any given aggregate price level rises, and the AD curve shifts to the right.

When actual real GDP falls short of potential output, the Federal Reserve and other central banks prefer to engage in expansionary monetary policy.

When the economy falls, the propensity for tax income to decline and transfers to rise serves to limit the size of recessions. However, declining tax income and growing welfare payments are driving the budget into the red. If the government was bound by the balanced-budget rule, it would have to respond to the deficit with contractionary fiscal measures, which would exacerbate the recession.

Conversely, policymakers worried about large deficits may believe that strict regulations preventing — or at least limiting — deficits are required.

The federal government's overall debt was $16.7 trillion at the end of fiscal 2013 or almost 100% of GDP. Nevertheless, some of that debt reflected unique accounting rules stating that the federal government as a whole owed money to certain government programs, like Social Security.

The US government's greatest implicit obligations stem from two transfer programs that mostly benefit the elderly: Social Security and Medicare. Medicaid, the third-largest implicit responsibility, helps low-income households. The government has pledged to provide transfer payments to both future and present recipients in each of these situations.

A government that pays high amounts in interest must either generate more money from taxes or spend less than it could otherwise afford—or borrow much more to make up the difference. Furthermore, a government that borrows to pay interest on its outstanding debt is putting itself further into debt.

The concept of government defaulting may seem far-fetched, but it is not out of the realm of possibility. Argentina, a relatively high-income developing country, was acclaimed for its economic policies in the 1990s, and it was able to borrow substantial sums from international lenders. Argentina's interest payments, on the other hand, had spiraled out of control by 2001, and the nation had stopped paying the sums due.

Argentina eventually negotiated an agreement with most of its creditors, paying less than a third of the total debt. In 2012, as Greece's government neared collapse, bondholders decided to exchange their bonds for new ones worth less than half as much.

Default disrupts a country's financial markets and erodes public trust in both the government and the economy.

States enjoyed financial surpluses after WWII, but the federal government's budget slipped back into deficit in 1950 when the Korean War broke out. The national debt had risen to $248 billion by 1962.

Stanford economist John Taylor proposed in 1993 that monetary policy should be guided by a simple formula that takes into consideration both business cycle and inflation concerns. The Taylor rule for monetary policy is a formula for determining the federal funds rate that takes both inflation and the output gap into account.

The rule that is suggested by Taylor was as follows:

• Federal funds rate = 1 + (1.5 x infection rate) + 0.5 x output gap)

The rule proposed by Taylor is that actual monetary policy often looks as if the Federal Reserve is following the proposed rule more or less.

This political asymmetry explains how nations that don't need to impose an inflation tax may end up with significant inflation issues. Inflationary measures typically provide short-term political advantages, while efforts to bring inflation down have short-term political costs.