Balanced budget

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A balanced budget (particularly that of a government) is a budget in which revenues are equal to expenditures. Thus, neither a budget deficit nor a budget surplus exists (the accounts "balance"). More generally, it is a budget that has no budget deficit, but could possibly have a budget surplus. [1] A cyclically balanced budget is a budget that is not necessarily balanced year-to-year but is balanced over the economic cycle, running a surplus in boom years and running a deficit in lean years, with these offsetting over time.

Contents

Balanced budgets and the associated topic of budget deficits are a contentious point within academic economics and within politics. Some economists argue that moving from a budget deficit to a balanced budget decreases interest rates, [2] increases investment, [2] shrinks trade deficits and helps the economy grow faster in the longer term. [2] Other economists, [3] especially (but not limited to) those associated with Modern Monetary Theory (MMT), downplay the need for balanced budgets among countries that have the power to issue their own currency, and argue that government spending helps boost productivity, innovation and savings in the private sector. [4]

Economic views

Mainstream economics mainly advocates a cyclic balanced budget, arguing from the perspective of Keynesian economics that permitting the deficit to vary provides the economy with an automatic stabilizer—budget deficits provide fiscal stimulus in lean times, while budget surpluses provide restraint in boom times. Keynesian economics does not advocate for fiscal stimulus when the existing government debt is already significant.

Alternative currents in the mainstream and branches of heterodox economics argue differently, with some arguing that budget deficits are always harmful, and others arguing that budget deficits are not only beneficial, but also necessary.

Schools which often argue against the effectiveness of budget deficits as cyclical tools include the freshwater school of mainstream economics and neoclassical economics more generally, and the Austrian school of economics. Budget deficits are argued to be necessary by some within post-Keynesian economics, notably the chartalist school:

Larger deficits, sufficient to recycle savings out of a growing gross domestic product (GDP) in excess of what can be recycled by profit-seeking private investment, are not an economic sin but an economic necessity. [5]

Budget deficits can be calculated by subtracting the total planned expenditure from the total available budget. This will then show either a budget deficit (a negative difference) or a budget surplus (a positive difference).

Modern Monetary Theory

Modern Monetary Theory (MMT) is a school of thought founded by economist Bill Mitchell and Hedge Fund Manager Warren Mosler, and has since been further developed by economists such as Stephanie Kelton and Randle Wary. [6] MMT advocates argue that a balanced budget is not required in the short term, or over the course of the business cycle in countries with monetary sovereignty, defined as follows:

A monetary sovereign is a country which:

  1. Issues its own currency,
  2. Does not fix its currency's exchange rate to another currency or commodity, and
  3. Does not have significant levels of foreign currency-denominated debt. [7]

Because such a country can issue its own currency, it can never run out of that currency and does not need to increase revenues in order to increase expenditure. Thus, the only constraint on expenditures is the inflation which it may generate if the economy is making full use of its capital and labour.. MMT advocates therefore argue for that budget deficits should be used to achieve full employment through a government employment program called a 'jobs guarantee'. This is based on the view that a government deficit creates a 'private sector surplus' by increasing incomes and creating savings. [8]

Political views

United States

In the United States, the fiscal conservatism movement believes that balanced budgets are an important goal. Every state other than Vermont has a balanced budget amendment, providing some form of ban on deficits, while the Oregon kicker bans surpluses of greater than 2% of revenue. The Colorado Taxpayer Bill of Rights (the TABOR amendment) also bans surpluses and requires the state to refund taxpayers in event of a budget surplus.

The last time that the budget was balanced or had a surplus was the 2001 United States federal budget.

Numerous sources have stated that as of 2023, a balanced budget is no longer possible without massive reductions in spending by the United States federal government according to the Congressional Budget Office [9] and several independent sources. [10] [11] Extreme spending reductions on numerous entitlements would also not likely be popular, even if such cuts would be sufficient to bring a balanced budget to the United States, "Federal debt will rise from 98 percent of GDP in 2023 to 181 percent in 2053." [12]

Sweden

Following the over-borrowing in both the public and private sector that led to the Swedish banking crisis of the early 1990s and under influence from a series of reports on the future demographic challenges, a wide political consensus developed on fiscal prudence. In the year 2000 this was enshrined in a law that stated a goal of a surplus of 2% over the business cycle, to be used to pay off the public debt and to secure the long-term future for the cherished welfare state. Today the goal is 1% over the business cycle, as the retirement pension is no longer considered a government expenditure.

United Kingdom

In 2015 George Osborne, the Chancellor of the Exchequer, announced that he intended to implement a law whereby the government must deliver a budget surplus if the economy is growing. [13] Academics have criticised this proposal with Cambridge University professor Ha-Joon Chang saying the chancellor was turning a blind eye to the complexities of a 21st-century economy that demanded governments remain flexible and responsive to changing global events. [14]

Since 1980, there have been only six years in which a budget surplus has been delivered: twice when the Conservatives' John Major was Chancellor of the Exchequer, in 1988 and 1989, and four times when Labour's Gordon Brown was Chancellor, in 1998, 1999, 2000 and 2001. [15]

Balanced budget multiplier

Because of the multiplier effect, it is possible to change aggregate demand (Y) keeping a balanced budget. Suppose the government increases its expenditures (G), balancing the increase by an increase in taxes (T). Since only part of the income taken away from households would have actually been spent, the change in consumption expenditure will be smaller than the change in taxes. Therefore, the net change in spending (increased government spending and decreased consumption spending) at this point is positive, and the induced second and subsequent rounds of spending are also positive, giving a positive result for the balanced budget multiplier. In general, and in the absence of induced changes in interest rates and the price level, a change in the balanced budget will change aggregate demand by an amount equal to the change in spending. Let the consumption function be:

The goods market equilibrium equation is:

where I is exogenous physical investment and NX is net exports. Using the first equation in the second one yields the following solution for Y:

and taking differences of the variables and setting and we have

Then dividing through by gives the balanced budget multiplier as

[16]

This is named the Haavelmo theorem which demonstrates that the balanced budget multiplier rises its maximum value when any increase of the public spending is corresponded by an equal increase of the fiscal imposition , so as to avoid a higher level of public debt. The deficit spending, that is the growth of public spending without an equal amount of monetary entrance into the State Treasury, is always a less efficient political choice in order to speed up the GNP.

However, the balanced budget is made smaller when resulting changes in the interest rate change investment spending and money demand and when resulting changes in the price level affect money demand.

See also

Related Research Articles

Keynesian economics are the various macroeconomic theories and models of how aggregate demand strongly influences economic output and inflation. In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy. It is influenced by a host of factors that sometimes behave erratically and impact production, employment, and inflation.

<span class="mw-page-title-main">Fiscal policy</span> Use of government revenue collection and expenditure to influence a countrys economy

In economics and political science, fiscal policy is the use of government revenue collection and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variables developed in reaction to the Great Depression of the 1930s, when the previous laissez-faire approach to economic management became unworkable. Fiscal policy is based on the theories of the British economist John Maynard Keynes, whose Keynesian economics theorised that government changes in the levels of taxation and government spending influence aggregate demand and the level of economic activity. Fiscal and monetary policy are the key strategies used by a country's government and central bank to advance its economic objectives. The combination of these policies enables these authorities to target inflation and to increase employment. In modern economies, inflation is conventionally considered "healthy" in the range of 2%–3%. Additionally, it is designed to try to keep GDP growth at 2%–3% percent and the unemployment rate near the natural unemployment rate of 4%–5%. This implies that fiscal policy is used to stabilise the economy over the course of the business cycle.

In economics, the fiscal multiplier is the ratio of change in national income arising from a change in government spending. More generally, the exogenous spending multiplier is the ratio of change in national income arising from any autonomous change in spending. When this multiplier exceeds one, the enhanced effect on national income may be called the multiplier effect. The mechanism that can give rise to a multiplier effect is that an initial incremental amount of spending can lead to increased income and hence increased consumption spending, increasing income further and hence further increasing consumption, etc., resulting in an overall increase in national income greater than the initial incremental amount of spending. In other words, an initial change in aggregate demand may cause a change in aggregate output that is a multiple of the initial change.

<span class="mw-page-title-main">Deficit spending</span> Spending in excess of revenue

Within the budgetary process, deficit spending is the amount by which spending exceeds revenue over a particular period of time, also called simply deficit, or budget deficit; the opposite of budget surplus. The term may be applied to the budget of a government, private company, or individual. Government deficit spending was first identified as a necessary economic tool by John Maynard Keynes in the wake of the Great Depression. It is a central point of controversy in economics, as discussed below.

<span class="mw-page-title-main">Government budget balance</span> Difference between revenues and spending

The government budget balance, also referred to as the general government balance, public budget balance, or public fiscal balance, is the difference between government revenues and spending. For a government that uses accrual accounting the budget balance is calculated using only spending on current operations, with expenditure on new capital assets excluded. A positive balance is called a government budget surplus, and a negative balance is a government budget deficit. A government budget presents the government's proposed revenues and spending for a financial year.

In economics, aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time. It is often called effective demand, though at other times this term is distinguished. This is the demand for the gross domestic product of a country. It specifies the amount of goods and services that will be purchased at all possible price levels. Consumer spending, investment, corporate and government expenditure, and net exports make up the aggregate demand.

In economics, the marginal propensity to consume (MPC) is a metric that quantifies induced consumption, the concept that the increase in personal consumer spending (consumption) occurs with an increase in disposable income. The proportion of disposable income which individuals spend on consumption is known as propensity to consume. MPC is the proportion of additional income that an individual consumes. For example, if a household earns one extra dollar of disposable income, and the marginal propensity to consume is 0.65, then of that dollar, the household will spend 65 cents and save 35 cents. Obviously, the household cannot spend more than the extra dollar. If the extra money accessed by the individual gives more economic confidence, then the MPC of the individual may well exceed 1, as they may borrow or utilise savings.

<span class="mw-page-title-main">Austerity</span> Economic policies intended to reduce government budget deficits

In economic policy, austerity is a set of political-economic policies that aim to reduce government budget deficits through spending cuts, tax increases, or a combination of both. There are three primary types of austerity measures: higher taxes to fund spending, raising taxes while cutting spending, and lower taxes and lower government spending. Austerity measures are often used by governments that find it difficult to borrow or meet their existing obligations to pay back loans. The measures are meant to reduce the budget deficit by bringing government revenues closer to expenditures. Proponents of these measures state that this reduces the amount of borrowing required and may also demonstrate a government's fiscal discipline to creditors and credit rating agencies and make borrowing easier and cheaper as a result.

In economics, a country's national saving is the sum of private and public saving. It equals a nation's income minus consumption and the government spending.

A balanced budget amendment is a constitutional rule requiring that a state cannot spend more than its income. It requires a balance between the projected receipts and expenditures of the government.

In macroeconomics, automatic stabilizers are features of the structure of modern government budgets, particularly income taxes and welfare spending, that act to damp out fluctuations in real GDP.

The Mundell–Fleming model, also known as the IS-LM-BoP model, is an economic model first set forth (independently) by Robert Mundell and Marcus Fleming. The model is an extension of the IS–LM model. Whereas the traditional IS-LM model deals with economy under autarky, the Mundell–Fleming model describes a small open economy.

<span class="mw-page-title-main">Debt-to-GDP ratio</span> Economic assessment of a countrys debt

In economics, the debt-to-GDP ratio is the ratio between a country's government debt and its gross domestic product (GDP). A low debt-to-GDP ratio indicates that an economy produces goods and services sufficient to pay back debts without incurring further debt. Geopolitical and economic considerations – including interest rates, war, recessions, and other variables – influence the borrowing practices of a nation and the choice to incur further debt.

In macroeconomics, the twin deficits hypothesis or the twin deficits phenomenon, is the observation that, theoretically, there is a strong causal link between a nation's government budget balance and its current account balance.

<span class="mw-page-title-main">Fiscal adjustment</span>

A fiscal adjustment is a reduction in the government primary budget deficit, and it can result from a reduction in government expenditures, an increase in tax revenues, or both simultaneously.

<span class="mw-page-title-main">Fiscal policy of the United States</span>

Fiscal policy is any changes the government makes to the national budget to influence a nation's economy. "An essential purpose of this Financial Report is to help American citizens understand the current fiscal policy and the importance and magnitude of policy reforms essential to make it sustainable. A sustainable fiscal policy is explained as the debt held by the public to Gross Domestic Product which is either stable or declining over the long term". The approach to economic policy in the United States was rather laissez-faire until the Great Depression. The government tried to stay away from economic matters as much as possible and hoped that a balanced budget would be maintained. Prior to the Great Depression, the economy did have economic downturns and some were quite severe. However, the economy tended to self-correct so the laissez faire approach to the economy tended to work.

Modern monetary theory or modern money theory (MMT) is a heterodox macroeconomic theory that describes currency as a public monopoly and unemployment as evidence that a currency monopolist is overly restricting the supply of the financial assets needed to pay taxes and satisfy savings desires. According to MMT, governments do not need to worry about accumulating debt since they can create new money by using fiscal policy in order to pay interest. MMT argues that the primary risk once the economy reaches full employment is inflation, which acts as the only constraint on spending. MMT also argues that inflation can be addressed by increasing taxes on everyone to reduce the spending capacity of the private sector.

Fiscal sustainability, or public finance sustainability, is the ability of a government to sustain its current spending, tax and other policies in the long run without threatening government solvency or defaulting on some of its liabilities or promised expenditures. There is no consensus among economists on a precise operational definition for fiscal sustainability, rather different studies use their own, often similar, definitions. However, the European Commission defines public finance sustainability as: the ability of a government to sustain its current spending, tax and other policies in the long run without threatening the government's solvency or without defaulting on some of the government's liabilities or promised expenditures. Many countries and research institutes have published reports which assess the sustainability of fiscal policies based on long-run projections of country's public finances. These assessments attempt to determine whether an adjustment to current fiscal policies that is required to reconcile projected revenues with projected expenditures. The size of the required adjustment is given with measures such as the Fiscal gap. In empirical works, weak and strong fiscal sustainability are distinguished. Differences are related to both econometric techniques used for examination and variables involved.

<span class="mw-page-title-main">Sectoral balances</span> Sectoral analysis framework

The sectoral balances are a sectoral analysis framework for macroeconomic analysis of national economies developed by British economist Wynne Godley.

The monetary/fiscal policy debate, otherwise known as the Ando–Modigliani/Friedman–Meiselman debate, was the exchange of viewpoints about the comparative efficiency of monetary policies and fiscal policies that originated with a work co-authored by Milton Friedman and David I. Meiselman and first published in 1963, as part of studies submitted to the Commission on Money and Credit.

References

  1. ↑ O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action . Upper Saddle River, New Jersey: Pearson Prentice Hall. pp.  376, 403. ISBN   0-13-063085-3.
  2. 1 2 3 "Winners and Losers In a Balanced Budget". The Washington Post. 4 May 1997.
  3. ↑ "Paul Krugman: Does America have too much debt?". The Irish Times. Retrieved 2024-02-18.
  4. ↑ Matthews, Dylan (2019-04-16). "A very detailed walkthrough of Modern Monetary Theory, the big new left economic idea". Vox. Retrieved 2021-05-18.
  5. ↑ ( Vickrey 1996 , Fallacy 1)
  6. ↑ "Modern Monetary Theory (MMT): Definition, History, and Principles". Investopedia. Retrieved 2023-12-22.
  7. ↑ Hail, Steven (2017-01-31). "Explainer: what is modern monetary theory?". The Conversation. Retrieved 2023-12-22.
  8. ↑ Kelton, Stephanie (2020). The deficit myth: modern monetary theory and the birth of the people's economy (First ed.). New York: PublicAffairs. ISBN   978-1-5417-3618-4.
  9. ↑ "The 2023 Long-Term Budget Outlook | Congressional Budget Office". www.cbo.gov. 2023-06-28. Retrieved 2023-07-31.
  10. ↑ Tuccille, J. D. (2023-07-26). "Under multiple budget scenarios, the government's numbers still don't add up". Reason.com. Retrieved 2023-07-31.
  11. ↑ "Government's Fiscal Path "Unsustainable" | U.S. GAO". www.gao.gov. 2020-02-27. Retrieved 2023-07-31.
  12. ↑ Boehm, Eric (2023-06-29). "CBO projects huge deficits, $116 trillion in new borrowing over the next 30 years". Reason.com. Retrieved 2023-07-31.
  13. ↑ "Osborne confirms Budget surplus law". BBC News. 10 June 2015. Retrieved 27 February 2017.
  14. ↑ Inman, Phillip (12 June 2015). "Academics attack George Osborne budget surplus proposal". The Guardian. Retrieved 27 February 2017.
  15. ↑ Rogers, Simon; Kollewe, Julia (22 May 2013). "Deficit, national debt and government borrowing - how has it changed since 1946?". The Guardian. Retrieved 27 February 2017.
  16. ↑ Jonathan Law; John Smullen (eds.). "balanced budget multiplier". A Dictionary of Finance and Banking . Retrieved 2024-02-18– via Oxford Reference.
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