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Policy Debates

Problems

Budget Deficit

Test

Problem : What is the budget deficit?

The budget deficit is the difference between what the government spends and what the government collects.

Problem : Explain the traditionalist view of the budget deficit.

Traditionalists argue that a reduction in the budget deficit will significantly help the economy in the long run. This theory is based on the logic that when the government runs a budget deficit, it is spending more than it is taking in. In this way, national savings decreases. When national savings decreases, investment--the primary store of national savings--also decreases. Lower investment leads to lower long-term economic growth. Similarly, lower investment is accompanied by higher domestic interest rates, which decreases net exports. Based on this logic, a budget deficit is a long-term drain on the economy.

Problem : Explain the Ricardian view of the budget deficit.

Supporters of the Ricardian view believe that a budget deficit represents trading taxes in the future for taxes today. That is, if the government spends more than it taxes today, then it must tax more than it spends tomorrow. Given that the public intrinsically understands this, a questionable premise, then the public will spend and save accordingly. Since the public is adjusting its spending and savings to account for this future increases in taxes, the budget deficit should have little long-term effect on economic growth.

Problem : Explain the fringe view of the budget deficit.

The fringe view of the budget deficit maintains that the budget deficit is measured incorrectly and therefore has little real effect on the economy in the long run.

Problem : What is the major way in which the national debt negatively impacts the economy in the long run?

The major way that the national debt negatively impacts the economy in the long run is by crowding out investment in capital goods and thereby lowering future productivity.

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