Question

The Australian government has recently announced a raft of fiscal expansionary/stimulus measures that will lead to a significant increase in the Australian government’s budget deficit. Given the material presented in this course cover the pros and cons of budget surpluses and deficits, we know that one view put forward is that ‘government budget deficits are bad. Do you agree or disagree with this statement? Briefly justify your answer

Answer 1

I agree with that Statement. This is because in the market for loanable funds, an increase in budget deficit leads to an increase in demand for loanable funds. This creates an excess demand for loanable funds at the existing interest rate. Now, this leads to an increase in interest rate. Increase in interest rate leads to a Decrease in Investment Spending in the Economy. Decrease in Investment Spending leads to Decrease in capacity of the economy to produce output. This leads to a Decrease in Potential Output in the Economy. This is why Government deficits are bad.