This article summarizes the simple analytics of the macroeconomic effects of government budget deficits. The presentation is organized around three key relationships: the national income accounts budget deficit identity, the deficit financing identity, and the dynamic equation for the evolution of the ratio of public debt to gross national product. The national income accounts identity highlights the effect of the deficit on domestic saving and investment and the current account. Examining the financing of the deficit brings to light the different kinds of macroeconomic imbalance the deficit can cause-as a first approximation, printing money excessively shows up as inflation, excessive use of foreign reserves leads to crises in the balance of payments, high foreign borrowing leads to a debt crisis, and too much domestic borrowing leads to high real interest rates and crowding out of private investment. The debt dynamics equation is used to show the long-run constraints on fiscal policy.
ASJC Scopus subject areas
- Economics and Econometrics