The worry about fiscal deficit

D. Murali | Updated on: Apr 12, 2011

BL09TAXBK1 | Photo Credit: Scanned in Chennai_grrks

In the recent economic meltdown, the role of fiscal policy in stimulating economies has been rediscovered, writes Shyamal Roy in Macroeconomic Policy Environment: An analytical guide for managers , second edition ( ).

The logic, as he explains, has been that since actual GDP equals aggregate demand for goods and services in the economy, and a slowdown or recession is caused because aggregate demand growth is deficient, calling therefore for macroeconomic policies that give a boost to demand.

However, the task of augmenting demand may become difficult, if demand does not respond to policy stimulation, Roy reminds. That can happen, he adds, if the slowdown/ recession is caused by a major shock in the economy. “In a severe slowdown/ recession of the type witnessed recently, private sector demand, because of negative sentiment may not proportionately respond to interest rate and tax rate changes; similarly, the ability of policies to give a boost to export demand is limited by the rate of growth of GDP of the buyer countries.”

The only recourse, then, to stimulate demand is to step up discretionary government expenditure, the author prescribes. “This is precisely what has been happening across the world. Whatever revival that we see in the global economies today is on account of massive fiscal stimulation.” But there is a catch, cautions Roy. The catch, as he notes, is that the increase in government expenditure is met not out of governments' own income but out of borrowed money, resulting in a substantial jump in the fiscal deficit and the size of the government debt.

Instructive read.


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Published on April 09, 2011
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