Budget Deficits and the Effect of Austerity Measures

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Budget Deficits and the Effect of Austerity Measures

The budget balance of a government usually comprises the difference in spending and government revenue, specifically taxes. Usually, when the amount of revenue is much larger than spending, the balance indicates that a budget surplus exists. However, if the amount of spending is larger than revenue, then a budget deficit is evident. Budget surpluses pose a positive effect on the national economy, specifically in terms of increased economic growth. Nevertheless, with budget deficits, the economy stands to gain national debt, which arises over the accumulation of budget deficits on an annual basis. The economy will be affected due to the displacement of productive investments and increased risks due to debt crises.

With significant budget deficits, the economy may undergo a series of negative effects, which affect its growth. Foremost, finances will be directed towards the mitigation of the deficit and the accumulated debt. This may cause crowding out of private and productive investments. Additionally, the money borrowed to cover the deficits will be directed towards consumption spending such as social security, Medicaid, or Medicare reimbursements. However, this will not aid in boosting the economy’s ability to produce further restricting potential economic growth and therefore, the economy’s GDP. As such, a worsened economic state will increase the burden associated with reimbursing the national debt.

Due to threats arising from budget deficits, austerity measures are usually implemented in order to decrease spending by the government. The adoption of such policies allows the government to reduce its negative budget balances by either restricting government expenditure or increasing taxes. However, austerity measures tend to pose a less positive effect on the government’s position in contrast to policymakers’ expectations. Since such measures are based on spending cuts, they pose a considerable negative effect on the real GDP. Government expenditure cuts lead to decreased aggregate demand and therefore, lower the respective GDP. Moreover, this decrease in real GDP leads to a fall in tax revenues but an increase in welfare spending. Hence, regardless of spending cuts, the budget situation is not improved since the rise in recession-based borrowing overshadows the spending cuts as evidenced by the effects of Greece’s failed austerity policies.