Should We Worry About the Size of Fiscal Deficit?

At the time of this writing, the US is currently running a deficit of over $1.3 trillion. As the fiscal deficit grows, so does the government borrowings which need to be repaid along with the interest expense. The fiscal deficit is usually observed as a percentage of the country's GDP. The US fiscal deficit is ~8.5% of the GDP, which seems pretty high compared to ~3.2% in 2008. For some people this is a big cause of concern, while for others the concern is overrated.

Let's look at some of the reasons for against high fiscal deficit.

Why High Fiscal Deficit is a real concern?

  1. It leads to an increase in future taxes.
  2. If investors don't refinance, government may default, or print more money.
  3. Printing money will cause high inflation.
  4. Crowding-out effect. Increased government borrowing leads to an increase in interest rates, which leads to a decrease in aggregate demand. The purpose of spending more has failed.

Why High Fiscal Deficit is not that big a problem?

  1. If the debt raised is used for capital investment, it will pay off in the future.
  2. The government may want to consider tax reforms.
  3. If Ricardian equivalence holds true, this is not a problem as there won't be any impact on aggregate demand.
  4. Deficits can help in increasing GDP and employment.
  5. If most debt is raised domestically, the problem is not that big.

An analyst will need to read the high fiscal deficit figures in light of all of the above points to arrive at a fair judgment on the real harm done by high fiscal deficit.

What do you think about this situation of high fiscal deficit?

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