2.6.2. Distinction Between Government Budget (Fiscal) Deficit and Surplus

This study note for Edexcel economics covers the Distinction Between Government Budget (Fiscal) Deficit and Surplus

A government's budget reflects its fiscal policy and economic priorities, showcasing the balance between its expenditures and revenues. The terms budget deficit and budget surplus are used to describe the state of this balance.

Government Budget Deficit

Definition:

• A budget deficit occurs when government expenditures exceed government revenues in a given fiscal year.

Implications:

• The government must borrow money to cover the shortfall, increasing national debt.
• Can stimulate economic activity during a recession by increasing public spending.

Examples:

• United States (2009): The federal budget deficit surged to $1.4 trillion (9.8% of GDP) due to increased spending and reduced revenues during the Great Recession.
• United Kingdom (2020): The budget deficit increased significantly as the government implemented measures to combat the economic impact of the COVID-19 pandemic.

Government Budget Surplus

Definition:

• A budget surplus occurs when government revenues exceed government expenditures in a given fiscal year.

Implications:

• Allows the government to pay down debt or save for future needs.
• Can reduce aggregate demand if achieved through spending cuts or tax increases, potentially slowing economic growth.

Examples:

• United States (1998-2001): The federal government ran budget surpluses due to strong economic growth and fiscal discipline.
• Australia (2007-2008): Experienced a budget surplus before the Global Financial Crisis, allowing for increased fiscal stimulus during the downturn.

Key Differences

• Economic Impact:
  • Deficit: Can boost economic activity in the short term but may lead to higher debt and interest payments in the long term.
  • Surplus: Can reduce debt and interest payments, providing more fiscal space for future needs, but may slow economic growth if achieved through austerity measures.
• Policy Implications:
  • Deficit: Often used during recessions to stimulate the economy through increased public spending and tax cuts.
  • Surplus: Often aimed for during economic booms to prevent overheating and to build reserves for future downturns.

Real-World Applications

• COVID-19 Pandemic: Many countries, including the UK and the US, ran large deficits to support economies through stimulus packages and health spending.
• Eurozone Sovereign Debt Crisis (2010-2012): Several European countries faced high deficits and debt levels, leading to austerity measures and bailouts.

Economic Perspectives

Keynesian Perspective:

• Supports the use of budget deficits during economic downturns to stimulate demand and reduce unemployment.
• Advocates for surpluses during booms to prevent inflation and build reserves.

Classical Perspective:

• Emphasizes balanced budgets and fiscal discipline.
• Concerns about the long-term impact of deficits on national debt and interest rates.

Monetarist Perspective:

• Focuses on controlling the money supply rather than fiscal measures.
• Believes that fiscal policy should be predictable and sustainable to maintain investor confidence.

Key Economists' Contributions

John Maynard Keynes:

• Advocated for counter-cyclical fiscal policies, using deficits to combat recessions and surpluses during booms.

Milton Friedman:

• Criticized excessive government spending and advocated for monetary policy over fiscal interventions.

Joan Robinson:

• Contributed to Keynesian economics, emphasizing the role of fiscal policy in managing aggregate demand.

Janet Yellen:

• As Chair of the Federal Reserve, emphasized the importance of fiscal policy coordination with monetary policy to achieve economic stability.

Christina Romer:

• As an economic historian and policy advisor, highlighted the effectiveness of fiscal stimulus during economic downturns, such as the Great Recession.

Mariana Mazzucato:

• Advocates for strategic public investment and the role of government in driving innovation and long-term economic growth.

Timeline of Key Events

• 1930s: The Great Depression led to the development of Keynesian fiscal policy.
• 1980s: Shift towards fiscal conservatism and balanced budgets in many Western economies.
• 2008-2009: Global Financial Crisis resulted in significant budget deficits as governments implemented stimulus measures.
• 2010-2012: Eurozone Sovereign Debt Crisis led to austerity measures and debates over fiscal policy.
• 2020: COVID-19 pandemic caused unprecedented budget deficits as governments supported economies through fiscal stimulus.

Glossary

• Aggregate Demand: The total demand for goods and services within an economy.
• Austerity Measures: Policies aimed at reducing government deficits through spending cuts and tax increases.
• Balanced Budget: A situation where government revenues equal expenditures.
• Counter-cyclical Fiscal Policy: Fiscal policies that counteract economic fluctuations by stimulating demand during recessions and curbing demand during booms.
• Fiscal Policy: Government policies regarding taxation and spending to influence economic conditions.
• Monetarist: An economist who emphasizes the role of controlling the money supply in managing the economy.
• National Debt: The total amount of money that a government owes to creditors.
• Recession: A period of temporary economic decline, typically defined by a fall in GDP in two successive quarters.
• Stimulus Package: A set of government measures, typically involving increased public spending and tax cuts, aimed at boosting economic activity.

Possible Essay-Style Questions

1. Compare and contrast the economic impacts of a government budget deficit and a budget surplus.
2. Evaluate the effectiveness of counter-cyclical fiscal policies during economic downturns, using real-world examples.
3. Discuss the long-term implications of sustained budget deficits on national debt and economic stability.
4. Analyze the role of fiscal policy in managing aggregate demand, referencing Keynesian and classical economic theories.