Thursday, May 17, 2007

Evaluate Problems of High Government Borrowing.

government borrowing is when spending is higher than taxation revenue.

Problems from Government Borrowing.

1. Expansionary Fiscal Policy may cause Inflation

A Government deficit means Injections (government spending) are higher than withdrawals (taxations) Therefore, this has the effect of increasing AD. If the economy is close to full capacity and growing at the long run trend rate, higher AD may lead to inflationary growth. If the economy is in recession or growing below trend rate, higher borrowing may increase growth, without causing inflation.

2. Higher Taxes in the Future.

High borrowing now leads to higher taxes in the future; this is a burden on future generations. Higher income taxes may reduce productivity in the future.

3. Crowding Out.

This is an argument to say that higher government borrowing may lead to a fall in private sector spending and investment. This is because government borrowing means that they need to borrow from the private sector. If the government are borrowing from the private sector (selling bonds) it means they have less to spend. Therefore, there may not be any increase in AD. Furthermore, it is argued that government spending is more inefficient than private sector spending. Therefore government borrowing may cause greater inefficiency.
However, it depends on why the government are borrowing, if they are borrowing to finance investment in education, this may lead to an increase in productivity in the long term. Also, Keynesians argue government borrowing will not cause crowding out, if the economy is in recession the government is merely helping to use resources that are currently idle.

4. Financial Crowding out.

It is argued that high levels of government borrowing can put upward pressure on interest rates. This is because if the government need to borrow large sums of money, they may have to increase interest rates to attract enough investors. Higher interest rates will lead to lower growth and lower investment in the long term.

5. Demographic Factors will Exacerbate the problem in the future.

In many western economies, demographic factors will worsen government's fiscal positions in the future. This is because of the aging population. The baby boomer generation is about to retire, therefore, the government will have higher spending requirements and lower taxes.
Basically any problems in government problems will be exacerbated in the future.

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