What are the short- and long-term economic benefits and costsassociated with our

Question

What are the short- and long-term economic benefits and costsassociated with our current high federal government budgetdeficits? Do you think the economic benefits outweigh the economiccosts, or not? Why? If we wished to reduce the budget deficit thenhow would you advocate that be accomplished?
What are the short- and long-term economic benefits and costsassociated with our current high federal government budgetdeficits? Do you think the economic benefits outweigh the economiccosts, or not? Why? If we wished to reduce the budget deficit thenhow would you advocate that be accomplished?

Explanation / Answer

The short-term benefit of running the current deficit is that it keeps aggregate demand high and keeps us from falling into a liquidity trap. The short-term cost takes the form of crowding out private industry, making recovery from the recession more difficult. There are no long-term benefits of running a deficit. The long-term cost of running the deficit is paying the interest back on the loan we take out to finance the deficit.

The economic benefits outweigh the costs if we think that a liquidity trap is likely. Liquidity traps are terrible. They result in lots of lost jobs and increases in poverty. However, if we reduce the deficit and incur a liquidity trap, the liquidation of assets will causes prices to fall and induce economic growth and stability in the long-term. Whether you think the costs outweigh the benefits largely has to do with your temporal orientation. How much do you value the present relative to the future?

We can do one of two things to lower the deficit. We can raise taxes or lower spending. One might want to lower spending because there are lots of expensive projects that we might not think fit into the "proper role of government." However, raising taxes will less of an effect on the GDP because only a portion of tax increases reduce consumption where all of a reduction in government spending reduces the GDP.

Y = C(1-t)+G+I+NX

For example, if the CPI is 0.5, that means that a tax increase of $100 will decrease consumption by $50, which will decrease GDP by $50. However, a decrease in Government Spending by $100 will reduce the GDP by $100.

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