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Government Deficits and Public Debt Essay Example

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Government Deficits and Public Debt

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Government Deficits and Public Debt. Deficit occurs in a situation where government purchases and transfers which form the government spending exceed income in form of tax receipts. To cover the deficit in such a case, the government must borrow.The finances of most industrial economies by the end of World War 1 were never as they are presently. The economic boom which followed after world war one led to the reduction of public debt by the first quarter of the century. Currently, debt levels that are hitting the roof are not going to go away because of the vigorous growth strategies major economies have adopted. Moreover, the ageing population is not going to make matters any easier and have been aggravated by recent recession. Hubbard identified costs of deficits to the economy together with other studies of Rogoff (2009).

Conclusions about the cost of debt burden on growth pointed to the criticality of the situation. Friedman (1988) in his research paper, “Day of Reckoning” cautioned on the evils of high debts of the eighties.The rising of the federal government deficits led to the debates on the subject of effects of these debts on rates of interests. This featured prominently on the study by Friedman on capital formation. One of the models that try to explain this theory is the Keynesian IS-LM model or the IS-MP. The interest rates increase by the mere fact that deficits stimulate demand and keep the levels of output up (Hubbard and O’Brien 2011). However, the interest rate increase in the aggregate demand short run is different in a way in terms of effect than long run interest rate increase caused by the government debt shrouding private capital as discussed by Bernheim (1987). However, it is quite hard to construct a Keynesian platform for the measurement of the stimulus accrued from long term deficits and these covering up of private capital. Additionally, there are other factors apart from the government debt that affect interest rates.A good illustration of when other factors apart from government debt effects on interest rates, is when the authority on monetary issues look to purchase some of this government debt with the intention of expanding money supply, and keep the prices constant relatively (McCallum, 1984). This debt held by the monetary authority does not in any way cover up formation of private capital. However, many. Government Deficits and Public Debt.

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