Fiscal policy - budget deficit

CFA Level III Economics
#1

Can someone explain the following sentence copied from the CFA curriculum please?

When asked about the impact to promote growth in a country:

“A decrease in the long-term average budget deficit as a percent of GDP is pro-growth, because it would be a positive for controlling the current account deficit. Associated structural policy element: Fiscal policy is sound.”

Thanks very much!

#2

So i think what it is saying is:

Deficit is when the government spending is more than taxes.

(GOV spending - Taxes).

If this decreases, it means the government is collecitng more taxes, which means the overall GDP is growing and they are ABLE to collect more taxes.

#3

It more so implies the government isn’t spending itself into a currency/fiscal crisis. The key part of the statement is long-term.

In the short term an increase in the budget (speding) is pro growth, whether or not it increases the deficit should be analyzed with the information provided.

#4

Thank you both!

#5

I am reopening this rather old post. I have many issues with economics.

Do I undertand correctly that:

  • Increasing budget deficit is pro-growth on the short-term during a recession (quotation from the curriculum “decreasing a budget surplus (or increasing a budget deficit may be a justifiable economic stimulus during a recession”)
  • Decreasing budget deficit is pro-growth on the long-term (curriculum quotation above)

Thanks !

#6

Yes.

Spending is always pro-growth. Since by definition spending is growth. This may not be part of the curriculum, but fiscal spending does not always lead to overall economic growth, but the opposite, in fact, this is often the case due to poor public finance policy.

On the long term, a widening budget deficit and gross public debt as a percentage of GDP (not in absolute value, this is important), is not sustainable and will lead to severe austerity measures and inevitably, recession.

#7

Thanks MrSmart for the smart answer

#8

I think Galli’s and MrSmart’s responses nailed it. The operative phrase is “long-term.” Here’s our GDP formula:

GDP = C + G + I + NX

In the short-term , increasing the budget deficit (or reducing the surplus) is pro-growth. This can be thought of as a purely definitional truth, as government spending is one component of the GDP formula. However, the purpose of that spending is to try and stimulate the other elements of the formula (consumer spending, capital investment, and net exports). If successful in that endeavor, private sector growth (the other three elements of the formula, collectively) should drive greater GDP growth, which would allow the budget deficit to decline as a percentage of GDP over the long-term.

On the other hand, any long-term , sustained increase in the budget deficit as a percentage of GDP is NOT pro-growth. In that situation, debt as a percentage of GDP would be on a steady rise to the point that markets would lose faith in your economy’s ability to repay its debts, interest rates would skyrocket, consumers would become frightful and slow down spending and potentially even pull their money out of banks (causing banks to become less capitalized), business growth would slow and therefore less capital investments would be made, and your country would likely become non-competitive to the point that it is no longer able to export anything. This is basically the situation in Greece.