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  1. Account
  2. Accountancy
  3. Accountant
  4. Accounting cycle
  5. Accounting equation
  6. Accounting methods
  7. Accounting reform
  8. Accounting software
  9. Accounts payable
  10. Accounts receivable
  11. Accrual
  12. Adjusted basis
  13. Adjusting entries
  14. Advertising
  15. Amortization
  16. Amortization schedule
  17. Annual report
  18. Appreciation
  19. Asset
  20. Assets turnover
  21. Audit
  22. Auditor's report
  23. Bad debt
  24. Balance
  25. Balance Sheet
  26. Banking
  27. Bank reconciliation
  28. Bankruptcy
  29. Big 4 accountancy firm
  30. Bond
  31. Bookkeeping
  32. Book value
  33. British qualified accountants
  34. Business
  35. Business process overhead
  36. Capital asset
  37. Capital goods
  38. Capital structure
  39. Cash
  40. Cash flow
  41. Cash flow statement
  42. Certified Management Accountant
  43. Certified Public Accountant
  44. Chartered Accountant
  45. Chartered Cost Accountant
  46. Chart of accounts
  47. Common stock
  48. Comprehensive income
  49. Consolidation
  50. Construction in Progress
  51. Corporation
  52. Cost
  53. Cost accounting
  54. Cost of goods sold
  55. Creative accounting
  56. Credit
  57. Creditor
  58. Creditworthiness
  59. Current assets
  60. Current liabilities
  61. Debentures
  62. Debits and Credits
  63. Debt
  64. Debtor
  65. Default
  66. Deferral
  67. Deferred tax
  68. Deficit
  69. Deloitte Touche Tohmatsu
  70. Depreciation
  71. Direct tax
  72. Dividend
  73. Double-entry bookkeeping system
  74. Earnings before interest and taxes
  75. Earnings Before Interest, Taxes and Depreciation
  76. Earnings before Interest, Taxes, Depreciation and Amortization
  77. Engagement Letter
  78. Equity
  79. Ernst a& Young
  80. Expense
  81. Fair market value
  82. FIFO and LIFO accounting
  83. Finance
  84. Financial accounting
  85. Financial audit
  86. Financial statements
  87. Financial transaction
  88. Fiscal year
  89. Fixed assets
  90. Fixed assets management
  91. Fixed Assets Register
  92. Forensic accounting
  93. Freight expense
  94. Fund Accounting
  95. Furniture
  96. General journal
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  117. Inventory
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  120. Itemized deduction
  121. KPMG
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  125. Liability
  126. Licence
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  128. Liquid asset
  129. Long-term assets
  130. Long-term liabilities
  131. Management accounting
  132. Matching principle
  133. Mortgage
  134. Net Income
  135. Net profit
  136. Notes to the Financial Statements
  137. Office equipment
  138. Operating cash flow
  139. Operating expense
  140. Operating expenses
  141. Ownership equity
  142. Patent
  143. Payroll
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  145. Petty cash
  146. Preferred stock
  147. PricewaterhouseCoopers
  148. Profit
  149. Profit and loss account
  150. Pro forma
  151. Purchase ledger
  152. Reserve
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  154. Revaluation of fixed assets
  155. Revenue
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  157. Royalties
  158. Salary
  159. Sales ledger
  160. Sales tax
  161. Salvage value
  162. Shareholder
  163. Shareholder's equity
  164. Single-entry accounting system
  165. Spreadsheet
  166. Stakeholder
  167. Standard accounting practice
  168. Statement of retained earnings
  169. Stock
  170. Stockholders' deficit
  171. Stock option
  172. Stock split
  173. Sunk cost
  174. Suspense account
  175. Tax bracket
  176. Taxes
  177. Tax expense
  178. Throughput accounting
  179. Trade credit
  180. Treasury stock
  181. Trial balance
  182. UK generally accepted accounting principles
  183. United States
  184. Value added tax
  185. Value Based Accounting Standards and Principles
  186. Write-off

This article is from:

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From Wikipedia, the free encyclopedia


A budget deficit occurs when an entity (often a government) spends more money than it takes in. The opposite is a budget surplus.

The size of a governmental budget deficit is often an important political issue as well as one of economic policy. Fiscal conservatives denounce deficit spending and advocate balanced budgets. Keynesians argue that under some circumstances, deficit spending is justified. "Starve-the-beast" strategies usually lead to high budget deficits.

An accumulated deficit over several years (or centuries) is referred to as the government debt. Often, a certain part of spending is dedicated to paying of debt with certain maturity, which can be refinanced by issuing new government bonds. That is, a fiscal deficit leads to an increase in an entity's debt to others. A deficit is a flow. And a debt is a stock. Debt is essentially an accumulated flow of deficits.

Any deficit must, ultimately, be repaid, either through taxation, or seignorage. The Ricardian equivalence hypothesis states that this means a public deficit is exactly the same as a tax rise.

The existence of a deficit has in some cases led to the existence of a capital market and been a great benefit to economic activity.

A formula to calculate debt is:

Debt = RBt-1 + (r-g)Gt - Tt
R= real interest rate.
Bt-1= Debt of last year.
r = Interest Rate
g= growth rate
Gt= Government Spending
Tt = Tax Revenue.

Early Deficits

Before the invention of bonds, the deficit could only be financed with loans from private investors or other countries. A prominent example of this was the Rothschild dynasty in the late 18th and 19th century, though there were many earlier examples.

These loans became popular when private financiers had amassed enough capital to provide them, and when governments were no longer able to simply print money, with consequent inflation, to finance their spending.

However, large, long-term loans had a high element of risk for the lender and consequently gave high interest rates. Governments later tried to marketize their debts by issuing bonds that were payable to the bearer, rather than the original purchaser. This meant that someone who lent the state money could sell on the debt to someone else, reducing the risks involved and reducing the overall interest rates. Examples of this are British Consols and American Treasury bill bonds.

Structural and Cyclical Deficits

A government deficit can be thought of as consisting of two elements, structural and cyclical.

At the lowest point in the business cycle, there is a high level of unemployment. This means that tax revenues are low and expenditure (e.g. on social security) high. Conversely, at the peak of the cycle, unemployment is low, increasing tax revenue and decreasing social security spending. The need to borrow money at the low point of the cycle is a cyclical deficit. A cyclical deficit will be entirely repaid by a cycical surplus at the peak of the cycle.

A structural deficit is the deficit that remains across the business cycle, because general tax levels are too low for the general level of government spending.

The observed total budget deficit is equal to the sum of the structural deficit with the cyclical deficit or surplus.

The idea of cyclical vs. structural deficits has come under criticism by those economists who believe that the business cycle is too difficult to measure to make cyclical analysis worthwhile.

Possible Negative Economic Consequences of Deficits: Inflation and Crowding Out

Government deficits are not inherently inflationary. Historically, however, large government deficits have resulted in large and prolonged periods of inflation due to the monetization of government debt (monetary creation). As long as deficits are financed by the sale of government bonds (borrowing), they do not result in monetary creation, the principal cause of inflation. The theoretical causal link between the money supply and the price level is described by the quantity theory of money and most strongly advocated by Nobel prize winning macroeconomist Milton Friedman.

Deficits can lead to inflation if governments choose to finance deficits through monetary creation rather than borrowing. This often occurs because the large taxes necessary to finance spending are politically infeasible, and there is insufficient demand for government debt, i.e. investors refuse to buy government bonds. In other words, no one will lend the government money. This is often the case in less developed nations whose economies are too small to tax effectively, but whose governments are considered too risky to attract investors willing to lend out of fear of default. Thus, monetary creation is often the only alternative available to finance spending.

Inflationary deficits are not limited to developing nations, however. Significant monetization of debt often occurs in developed countries as a result of minimal or no independence of a nation's central bank from its treasury. The central bank is a body which determines interest rates and the nation's money supply, while the treasury finances government expenditures through revenue collection (taxation) or borrowing. A central bank subordinate to a nation's treasury forced to borrow presents a conflict of interest that threatens to cause significant monetization of debt, and thus inflation.

The lack of an independent central bank often leads to strong pressure from the treasury on the bank to purchase the treasury's bonds on the open market (essentially creating money) in order to bid up bond prices. This increase in demand (and consequently the price) for government bonds from the central bank leads to a decrease in the yield (interest rate) on the bonds. Note the inverse relationship between a bond's price and its yield. The yield on the bonds is essentially the cost of borrowing faced by the government. It is thus easy to see why a nation's treasury has a significant interest in the central bank maintaining low interest rates through monetary creation.

A nation's treasury has a further (but related) interest to pressure the central bank to buy government debt, creating money. As the treasury increasingly borrows (selling bonds), the increase in the supply of bonds leads to a steady decline in the bonds' price. As the price of the bonds falls, their yield increases, consequently increasing the government's cost of borrowing. Thus, governments face progressively increasing borrowing costs as deficits grow, and therefore have an increasing incentive to pressure the central bank to buy bonds to keep borrowing costs (interest rates) low.

This actually touches on arguably a more significant economic effect of large government deficits, i.e. higher interest rates. The massive sale of government debt raises interest rates across the economy, not just rates paid by the government, and draws available capital (economics) away from prospective private investments to the government. This problem is known as crowding out. Crowding out can actually result in lower investment and thus lower national income (GDP), working against any increase in GDP resulting from the increase in government spending. This can be illustrated using Keynesian macroeconomic theory.

The United States is no stranger to pressure exerted on its central bank. During World War I and World War II the U.S. Treasury put significant pressure on the Federal Reserve (America's central bank) to keep rates low. At the time, the Federal Reserve was much less independent from the Treasury than it is today, and massive monetary creation (and thus inflation) resulted in both instances. The inflation in WWII was considered desirable, however, as the Great Depression was plagued by massive deflation.

Most Western democratic nations have realized the inherent inflationary bias in a central bank under the treasury, and have taken significant steps to make their central banks much more independent in leadership and appropriations. An independent central bank is universally regarded by macroeconomists to be positive for economic growth and the macroeconomy as a whole, as the bank is more free to set interest rate policy and contract or expand the money supply as it sees fit. Independence insulates the central bank from expansionary pressure from many sources for lower interest rates which in the short term may bring about lower borrowing costs and rapid growth, but in the long run may cause undesirable and economically harmful inflation. In fact, it seems that there is a direct relationship between the level of independence of a nation's central bank and a nation's level of inflation. More independent central banks seem to better control inflation, maintaining a much lower rate of increase in the aggregate price level.

It is unlikely today that the Federal Reserve or the central banks of other Western democracies will monetize debt as they have in the past, as a healthy fear of inflation has taken hold of central bankers and economists of all political persuasions the world over. It is estimated that a small percentage of U.S. government debt is monetized each year, though the effect of this on inflation is minimal. Less developed and democratic nations however still struggle with large government deficits, monetary creation, and high inflation.

Top Ten National Budgets (2004)

(Data from CIA Factbook and List of countries by GDP (nominal),,

See also

  • Fiscal Policy in the United States
  • Starve-the-beast philosophy
  • U.S. public debt
  • Rey Student

External links

  • U.S. Congressional Budget Office
  • The Budget Graph: A graphical representation of the 2007 United States federal discretionary budget, including the public debt.
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