What is debt. What is a deficit What is debt? What is a deficit? What are the problems with running a deficit? http://www.bbc.co.uk/news/business-25944653

Government spending Fact & figure hunt How much have the government spent in the past years? What have they spent it on? What are the two types of spending? How much tax revenue do they get? From where specifically? How big is the UK deficit?

Problems with a deficit A persistently large budget deficit can be a problem. Three of the reasons for this are as follows: Financing a deficit A government debt mountain Capital flight In a world where financial capital flows freely between countries, it can be fairly easy to finance a deficit. But if the budget deficit rises to a high level, in the medium term the government may have to offer higher interest rates to attract sufficient buyers of debt. This raises the possibility of the government falling into a debt trap where it must borrow more simply to repay the interest on accumulated borrowing. because interest payments on bonds might be used in more productive ways, for example on health services or extra investment in education. 100 basis points equates to 1 per cent. Every 10 basis points (0.1%) saved on £100bn of new debt is worth £100 m pa, equivalent to pays one year’s salary for 46,000 teachers. Higher public sector debt also represents a transfer of income from people and businesses that pay taxes to those who hold government debt and cause a redistribution of income and wealth in the economy. As state debt rises, there is an opportunity cost involved Crowding-out - the need for higher interest rates and higher taxes. If a larger budget deficit leads to higher interest rates and taxation in the medium term and thereby has a negative effect on growth in consumption and investment spending, then a process of ‘fiscal crowding-out’ is said to be occurring. There must be a limit to which taxpayers are prepared to pay for government spending. The Institute of Fiscal Studies has estimated that that to reduce the UK budget deficit over the next five years will require every person in the UK to pay over £1250 of extra taxes each year. Risk of capital flight: Some economists believe that high levels of state borrowing and debt risk causing a ‘run on a currency’. This is because the government may find it difficult to find sufficient buyers of debt and the credit-rating agencies may decide to reduce the rating on sovereign debt. Foreign investors may choose to send their money overseas perhaps causing a currency crisis Potential benefits of a budget deficit Government borrowing can benefit growth: A budget deficit can have positive effects if it is used to finance capital spending that leads to an increase in the stock of national assets. For example, spending on transport infrastructure improves the supply-side capacity of the economy. And increased investment in health and education can boost productivity and employment. The budget deficit as a tool of demand management: Keynesian economists support the use of changing the level of government borrowing as a legitimate instrument of managing aggregate demand. An increase in borrowing can be a useful stimulus to demand when other sectors of the economy are suffering from weak or falling spending. If crowding out is not a major problem - fiscal policy can play an important counter-cyclical role “leaning against the wind” of the economic cycle

Taxes and rational expectations A school of economic thought stresses that economic agents make choices based on the information they have and a rational view of the future. Called rational expectations So when the government sells debt to fund a tax cut or an increase in expenditure, a rational individual will realise that at some future date he or she will face higher tax liabilities to pay for the interest repayments Thus, he should increase his savings as there has been no increase in his permanent income The implications are clear. Any change in fiscal policy will have no impact on the economy if all individuals are rational. Fiscal policy in these circumstances may become ineffective