Balanced budget

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A balanced budget (equilibrium)(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.

A government is the system or group of people governing an organized community, often a state.

Budget balance sheet or statement of estimated receipts and expenditures

A budget is a financial plan for a defined period, often one year. It may also include planned sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities and cash flows. Companies, governments, families and other organizations use it to express strategic plans of activities or events in measurable terms.

Revenue income that a business has from its normal business activities

In accounting, revenue is the income that a business has from its normal business activities, usually from the sale of goods and services to customers. Revenue is also referred to as sales or turnover. Some companies receive revenue from interest, royalties, or other fees. Revenue may refer to business income in general, or it may refer to the amount, in a monetary unit, earned during a period of time, as in "Last year, Company X had revenue of $42 million". Profits or net income generally imply total revenue minus total expenses in a given period. In accounting, in the balance statement it is a subsection of the Equity section and revenue increases equity, it is often referred to as the "top line" due to its position on the income statement at the very top. This is to be contrasted with the "bottom line" which denotes net income.

Contents

Balanced budgets and the associated topic of budget deficits are a contentious point within academic economics and within politics. Many 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]

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.

Mainstream economics is the body of knowledge, theories, and models of economics, as taught by universities worldwide, that are generally accepted by economists as a basis for discussion. Also known as orthodox economics, it can be contrasted to heterodox economics, which encompasses various schools or approaches that are only accepted by a minority of economists.

Keynesian economics are various macroeconomic theories about how in the short run – and especially during recessions – economic output is strongly influenced by aggregate demand. In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy; instead, it is influenced by a host of factors and sometimes behaves erratically, affecting production, employment, and inflation.

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

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.

Heterodox economics schools of economic thought or methodologies that are outside "mainstream economics", contrasting with or going beyond neoclassical economics

Heterodoxy is a term that may be used in contrast with orthodoxy in schools of economic thought or methodologies, that may be beyond neoclassical economics. Heterodoxy is an umbrella term that can cover various schools of thought or theories. These might for example include institutional, evolutionary, Georgist, Austrian, feminist, social, post-Keynesian, ecological, Marxian, socialist and anarchist economics, among others.

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:

Neoclassical economics is an approach to economics focusing on the determination of goods, outputs, and income distributions in markets through supply and demand. This determination is often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits by firms facing production costs and employing available information and factors of production, in accordance with rational choice theory, a theory that has come under considerable question in recent years.

Post-Keynesian economics is a school of economic thought with its origins in The General Theory of John Maynard Keynes, with subsequent development influenced to a large degree by Michał Kalecki, Joan Robinson, Nicholas Kaldor, Sidney Weintraub, Paul Davidson, Piero Sraffa and Jan Kregel. Historian Robert Skidelsky argues that the post-Keynesian school has remained closest to the spirit of Keynes' original work. It is a heterodox approach to economics.

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. [3]

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).

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.

Fiscal conservatism political ideology

Fiscal conservatism, also referred to as conservative economics or economic conservatism, is a political-economic philosophy regarding fiscal policy and fiscal responsibility advocating low taxes, reduced government spending and minimal government debt. Free trade, deregulation of the economy, lower taxes and privatization are the defining qualities of fiscal conservatism. Fiscal conservatism follows the same philosophical outlook of classical liberalism and economic liberalism. The term has its origins in the era of the New Deal during the 1930s as a result of the policies initiated by reform or modern liberals, when many classical liberals started calling themselves conservatives as they did not wish to be identified with what was passing for liberalism.

Vermont State in the United States

Vermont is a U.S. state in the New England region. It borders the states of Massachusetts to the south, New Hampshire to the east, and New York to the west, and the Canadian province of Quebec to the north. Vermont is the second-smallest by population and the sixth-smallest by area of the 50 U.S. states. The state capital is Montpelier, the least populous state capital in the United States. The most populous city, Burlington, is the least populous city to be the most populous city in a state. As of 2019, Vermont was the leading producer of maple syrup in the United States. In crime statistics, it has ranked since 2016 as the safest state in the country.

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.

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. [4] 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. [5]

Since 1980 there have only been six years when a budget surplus has been delivered, twice whilst the Conservative's John Major was Chancellor of the Exchequer in 1988 and 1989 and four times whilst Labour's Gordon Brown was Chancellor, in 1998, 1999, 2000 and 2001. [6]

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

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

IS–LM model Keynesian macroeconomic model about interest rates and assets markets that places general equilibrium (simultaneous equilibria in goods/asset markets) at the intersection of “investment–saving” (IS) and “liquidity preference–money supply” (LM)

The IS–LM model, or Hicks–Hansen model, is a two-dimensional macroeconomic tool that shows the relationship between interest rates and assets market. The intersection of the "investment–saving" (IS) and "liquidity preference–money supply" (LM) curves models "general equilibrium" where supposed simultaneous equilibria occur in both the goods and the asset markets. Yet two equivalent interpretations are possible: first, the IS–LM model explains changes in national income when price level is fixed short-run; second, the IS–LM model shows why an aggregate demand curve can shift. Hence, this tool is sometimes used not only to analyse economic fluctuations but also to suggest potential levels for appropriate stabilisation policies.

Fiscal policy use of government revenue collection and spending to influence the economy

In economics and political science, fiscal policy is the use of government revenue collection and expenditure (spending) to influence a country's economy. The use of government revenues and expenditures to influence macroeconomic variables developed as a result of the Great Depression, when the previous laissez-faire approach to economic management became discredited. Fiscal policy is based on the theories of the British economist John Maynard Keynes, whose Keynesian economics indicated that government changes in the levels of taxation and government spending influences 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 the inflation and to increase employment. Additionally, it is designed to try to keep GDP growth at 2%–3% and the unemployment rate near the natural unemployment rate of 4%–5%. This implies that fiscal policy is used to stabilize the economy over the course of the business cycle.

In economics, the fiscal multiplier is the ratio of a change in national income to the change in government spending that causes it. More generally, the exogenous spending multiplier is the ratio of a change in national income to any autonomous change in spending that causes it. When this multiplier exceeds one, the enhanced effect on national income is 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.

Deficit spending Spending in excess of revenue

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 is a central point of controversy in economics, as discussed below.

Government budget balance Difference between revenues and spending

A government budget is a financial statement presenting the government's proposed revenues and spending for a financial year. The government budget balance, also alternatively referred to as general government balance, public budget balance, or public fiscal balance, is the overall difference between government revenues and spending. A positive balance is called a government budget surplus, and a negative balance is a government budget deficit. A budget is prepared for each level of government and takes into account public social security obligations.

In macroeconomics, 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.

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.

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. Austerity measures are used by governments that find it difficult to pay their debts. The measures are meant to reduce the budget deficit by bringing government revenues closer to expenditures, which is assumed to make the payment of debt easier. Austerity measures also demonstrate a government's fiscal discipline to creditors and credit rating agencies.

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’s taxes levied.

In economics, crowding out is a phenomenon that occurs when increased government involvement in a sector of the market economy substantially affects the remainder of the market, either on the supply or demand side of the market.

In economics, aggregate expenditure (AE) is a measure of national income. Aggregate expenditure is defined as the current value of all the finished goods and services in the economy. The aggregate expenditure is thus the sum total of all the expenditures undertaken in the economy by the factors during a given time period. It is the expenditure incurred on consumer goods, planned investment and the expenditure made by the government in the economy. In an open economy scenario, aggregate expenditure also includes the difference between the exports and the imports.

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

Modern Monetary Theory also known as neo-chartalism, a macroeconomic theory

Modern Monetary Theory or Modern Money Theory (MMT) is a heterodox macroeconomic theory that describes currency as a public monopoly for the government 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. MMT is an evolution of chartalism and is sometimes referred to as neo-chartalism. Its macroeconomic policy prescriptions have been described as being a version of Abba Lerner's theory of functional finance.

In macroeconomics, a multiplier is a factor of proportionality that measures how much an endogenous variable changes in response to a change in some exogenous variable.

Keynesian cross diagram related to economic theory

The Keynesian cross diagram is a formulation of the central ideas in Keynes' General Theory. It first appeared as a central component of macroeconomic theory as it was taught by Samuelson in his textbook, Economics: An Introductory Analysis. The Keynesian Cross plots aggregate income and planned total spending or aggregate expenditure.

Sectoral balances

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 07458: 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. ( Vickrey 1996 , Fallacy 1)
  4. "Osborne confirms Budget surplus law". BBC News. 10 June 2015. Retrieved 27 February 2017.
  5. Inman, Phillip (12 June 2015). "Academics attack George Osborne budget surplus proposal". The Guardian. Retrieved 27 February 2017.
  6. 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.