Problems of allocation Deficits

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A funds deficit occurs when Government spending is greater than tax revenues. For political reasons a funds deficit often occurs. Politicians never gain votes by raising taxes and cutting spending. With many major World economies facing a large funds deficit. It is worth inspecting the main economic disadvantages of Government borrowing.

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Increased Borrowing

The govt will have to borrow from the underground sector, in the Uk the government does this by asking the Bank of England to sell bonds and gilts to the underground sector.

Higher debt interest payments

Selling bonds will growth the national debt, this is currently £300 billion. The every year interest payments is approximately £23 billion, this has a high opening cost because it requires hereafter generations to pay higher taxes.

Increased Ad

A funds deficit implies lower taxes and increased G, this will growth Ad and this may cause higher Real Gdp and inflation.

Higher Taxes and lower spending

In the hereafter the govt may have to growth taxes or cut spending in order to sell out the deficit. This may cause reduced incentives to work

Increased Interest rates

If the govt sells more bonds this is likely to cause interest rates to increase. This is because they will need to growth interest rates in order to attract investors to buy the extra debt.
If govt interest rates growth this will push up other interest rates as well.

Crowding Out

Increased govt borrowing may cause a decrease in the size of the underground sector (see fiscal policy)

Inflation

In ultimate circumstances the govt may growth the money provide to pay the debt, however this is unlikely to occur in the Uk

If the govt sells short term gilts to the banking sector then there wil be an growth in the money supply, this is because banks see gilts as near money therefore they can sound there lending to customers. however they will also be increasing the money provide by lending to the govt.

note the result of a funds deficit depends to some extent on the cause. For example in a recession a funds deficit may be vital to get the cheaper out of recession. If the government is borrowing to spend in infrastructure and instruction this can benefit the cheaper in the long term.

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