Why we sometimes need budget deficits
82
 | Amazon Price: $3.16 List Price: $9.95 |
 | Amazon Price: $5.00 List Price: $12.95 |
 | Amazon Price: $2.00 List Price: $14.99 |
With the second global financial crisis looming governments around the world are attempting to bring in a bunch of austerity measures. Here in Australia as in many other western countries the Government (Australian Labor Party) is hell bent on getting the domestic budget into surplus. It's as if it's some kind of addiction.
But is a surplus always good? If not why not? Are there some circumstances where budget deficits are needed? This article will attempt to answer these questions.
What is a domestic (Federal) budget?
In very basic terms a country's domestic budget is money in vs money out. Money in comes from taxes, the selling off of government assets and various charges on goods and services. Money out is just money that is spent by the government whether it be for education, roads, health and other programs. If more money is spent than received then the budget is in deficit. If more is received compared to spent than the budget is in surplus. In Australia the Federal Budget is divided amongst the various government departments.
Recently the Australian government pushed through two new taxes in order to raise revenue, the carbon tax and the resource rent tax. These taxes are expected to bring billions to the budget to help get it back into surplus by 2012-13 which has been the pledge made by Treasurer Wayne Swan. This will be difficult though given a series of natural disasters in Australia in 2011 such as Cyclone Yasi.
The first global financial crisis
Despite the Australian Government's commitment to a budget surplus economists in the main, are warning that a surplus is not a good thing at a time of global economic gloom and doom. It is generally agreed that Australia avoided the first global financial crisis by way of a economic stimulus package which was designed to keep people in jobs.
Money was poured into the economy especially in the form of new buildings for schools and every individual in Australia got money encouraging them to spend on retail to again keep people in jobs. This spending meant the federal budget went into deficit but the Australian economy kicked along and barely got a scratch as other countries went into free fall.
Can a budget deficit be good?
Some commentators have called the addiction to budget surpluses as deficit fetishism or deficit avoidance syndrome. It is also generally thought that deficits can be useful to avoid an economic slump (wheel in Australia and the GFC). Deficits only ever become redundant when the economy is operating at full employment and full capacity. When the economy is faltering and people have stopped spending (bunch of reasons for this) then it makes sense to stimulate demand by putting money into the economy (Keynesian Economics).
For instance the Australian Government committed to building new buildings for schools as a way to stimulate the economy. This meant builders, electricians, plumbers, suppliers etc had work and disposable income to spend which means more money into the economy and more people keeping their jobs particularly those working in the Australian travel industry.
Unfortunately it seems that having a budget surplus is synonymous with being a good economic manager but why in a time of an economic slump would you want to save money? Of course if a deficit is run the government must be careful not to overheat the economy which might cause inflation and therefore an increase in interest rates.
But if it appears the Australian economy is going to be effected by the debt crisis in Europe then a budget surplus may only make things worse. Just my opinion.
Read more about the Australian economy and politics:
 | Amazon Price: $4.69 List Price: $14.00 |
 | Amazon Price: $24.77 List Price: $44.75 |
 | Amazon Price: $0.00 |
- How Australia Avoided the Global Financial Crisis
In 2007-08 the world went into financial meltdown. Stocks fell, investors panicked, people stopped spending and thousands lost their homes and businesses. The impact of the 2008 global financial crisis reverberated throughout the globe.
- What is carbon tax?
Over the last 6 months or so Australia has been preoccupied with a cost benefit argument of the carbon tax. The Australian Labor Government (ALP) want to introduce it and the Liberal Party are vehemently against it. But what is carbon tax.
- President Obama in Australia: Julia Gillard and Bara...
Here in Australia we have just had the United States President Barack Obama visit our shores. It was a short visit but one which has seemingly boosted the opinion polls of Australian Labor Prime Minister Julia Gillard.
CommentsLoading...
No my inference is Australia applied Keynesian theory in the face of the first global financial crisis. Stimulus spending was aimed at increasing demand and therefore keeping people in jobs. The deficit was a result of cyclical and structural factors.
So we can deduce that the Keynesian theory works for a damaged economy?
Do I understand you to be saying that, for instance, laying off government workers creates more unemployment which generates less spending which renders a society more depressed? It makes sense to me that the government would hang on to it's employees and create more jobs during times such as these. Dang logical. But does logic play into politics?
Who are you talking to?
Keynes is no panacea however in the case of Australia avoiding the 1st GFC the government did invoke the increased expenditure on capital part of the theory and it seemingly worked.
Um, I am talking to the writer of this hub! I am not engaged in your conversation, as I am unclear what you mean, lol. However, I do find Harrys article and approach intriguing. I am not afraid to show my ignorance. How else will I learn?
Harry, I am seeking tangible examples of what you are describing, as opposed to discussing Keynesian Theory, which I did not study much in graduate school.
I was asking for you to respond to possible effects of a policy that allows deficits in tis thinking as opposed to one that wishes to eliminate deficits. And its effect on the particular people who struggle to exist underneath such policies. Thanks.
An example is provided in the hub with the Australian Government investing in capital works for schools around the country. This investment obviously meant a whole of tradespeople had jobs for quite some time plus their wages (disposable income) put more money into the economy a proportion of which they would spend on retail and goods & services which increases demand which in turn maintains and sometimes creates jobs. Very simplistic view of Keynesian theory but the Government admitted the theory was being in practice.
I don't see in what way it wouldn't be a panacea since it succeeded in Australia and since no other country put it into practice? It bare its fruits. I know that every economy is different (not that much though), that every nation balances between its strengths and weaknesses, but it would be the opportune occasion to prove its validity on a larger scale as they did with capitalism.
I agree but Australia was in an unique position compared to other countries because interest rates and inflation was low and there was a federal budget surplus. Therefore there was room to move so to speak with domestic spending not causing too much inflationary pressure. In this respect the importance of having a surplus in good times was seen.
Harvey, when I try to understand a subject I tend to paraphrase what I read to see if I got it right. In this case, government workers are teachers. So I guess my simplistic example was accurate. Yay. But a budget surplus is very different. Is our budget deficit and resultant huge interest payments a reason this might not be advisable?
Congrats to Australia for their innovative response to economics!
I must clarify, research (Battin) has shown that budget deficits do not produce as much inflationary pressure as thought ie other factors must also be present so the opposition scare mongering that deficits are always a sign of poor economic management is a misnomer. Teachers would have always kept their jobs, it's the so called other 'fat' in the public sector e.g. support services, admin etc where the government can look to shed in lean times in order to reduce costs but yes Keynes theory would say this would dampen demand and therefore make the situation worse.
Thanks, HarryMcG. I think I am beginning to understand!
I was thinking...Which country doesn't have a budget deficit? But, since it is related to Australia that just applied a Keynesian approach, I was wondering if this deficit is directly linked to the superiority of spending over revenues, or other factors, if yes which ones?
I am under the impression that scholars in economics know nothing since it is always in a theoretical stage.
The deficit initially was related to spending (structural deficit) but then it worsened over the financial year because of a series of natural disasters in Australia & overseas and a higher dollar (cyclical deficit). So it was a bit of both. Over the next financial year given the spending target had been reached to stimulate the economy for GFC I there should be a structural adjustment to reach a surplus but also a cyclical one if the world economy improves (not likely) and the dollar comes down a little.
What was the total of the structural deficit? The cyclical?
By referring to the dollar, are you implying that it affected the balance of trade? Isn't the Australian dollar inferior to the U.S., if it should benefit the Australian market!
Since Australia will experience a surplus, we shall push the rest of the world to imitate its behavior.
I don't know the percentage divisions between structural and cyclical adjustments of the deficit. The dollar did certainly affect the balance of trade higher dollar meant imports cheaper and exports dearer which is a double edged sword for the economy. The Australian dollar has been superior to the American Dollar for most of the year peaking around $1.08 and now around $1.02 to the US. Australia has shown the world what is possible but they had internal conditions which were favourable so it may not work for other countries.
Such as?
Internal conditions such as low inflation and low interest rates which could absorb capital expenditure without overheating the economy. Australia also has a strong regulatory framework for banks which meant the government guaranteed deposits. This meant banks weren't collapsing, credit was still available and people could still pay their mortgages.
Australia could become the model for a new paradigm of society.
As I said one of the main reasons Australia did what they did and it worked was because the economy was strong to start with a budget surplus to use so it didn't put inflationary pressure on the economy when a deficit resulted. Perhaps some lessons can be learnt from Australia but conditions have to be 'just so' for it to work. A little luck, good regulatory framework and some good economic management.
What is Australia's military expenditure? Is there an economic lesson in this? Didn't our deficit in America begin to skyrocket during the Bush administration commitment to "find bin Laden"? I believe we were spending a million or more a day? Does Australia have such a commitment to safeguard rhe world? (Sorry if this is a sidetrack.)
Australia's military expenditure in 2010 was about 1.9% of GDP or around $20billion dollars which has an effect on the budget deficit and has to be carefully considered each year. In the last 20 years or so it peaked around 1992-94 when it was around 2.1% and has since been hovering around 1.6-1.9%. In 2010 The US military expenditure was 4.7% of GDP or around $687 Billion dollars. A lot of money that no doubt has an impact on the economy in negative ways. Is it worth it? Only the American people can answer that.
maxoxam41 Level 5 Commenter 5 months ago
Are you inferring that with a Keynesian policy applied Australia ended up with a budget surplus or are theorizing?