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Twin Deficits Significance
Twin Deficits Significance
Twin Deficits Significance
John Maynard Keynes believed that fiscal deficit was essential for countries to
get out of an economic recession. Subsidies meant for the poor can help
increase their disposable income. This shall not only improve their standard of
living but also when they start consuming more goods and services, the
aggregate demand for these goods shall increase leading to a boost in the
economy.
Sustained high fiscal deficits would lead a government to increase its borrowing
substantially, leading to an increase in interest rates and printing more money in
order to decrease the gap. A rise in inflation will occur. The government will
have to borrow not just to repay the loans but to pay even the interest on those
loans. As the interest payments get high enough, it leads to a drag on economic
growth.
This is a debt trap and shall hurl the country towards bankruptcy in the future.
This creates the possibility of a sovereign default i.e. the country defaulting on
its loans.
But fiscal deficit is necessary for counter cyclical fiscal policy. Deficits should be
run during recession to compensate the shortage in the aggregate demand, but
during boom there should be surpluses in order to avoid structural deficit.
However fiscal conservatives (critics of Keynesian economics) believe that
governments should always run balanced budgets and in case there are debts
that need to be paid, surpluses should occur.
However, Chartalists believe that deficit spending is needed to create money
supply or to satisfy any demand for savings more than that can be met by
private investment.
Fiscal deficit can be viewed as good or bad depending on the context. If deficit is
used to finance projects that shall lead to economic well-being and progress in
the long run, they are good. However, if there is frivolous spending, these
deficits can be seen as unsustainable and damaging in the long run.