Budget deficits

The economic implications of federal government debt and deficits have been the source of much debate in the past, and will continue to be for many years to come. Economists are far from agreement with respect to the effects that government borrowing has on the economy. Two major schools of thought have emerged which arrive at seemingly contrary conclusions. One school of thought contends that government bonds are perceived as net wealth by the public, and that government borrowing crowds out private investment, while the other school of thought arrives at precisely the opposite conclusions. An empirical investigation was used to test the validity of the conclusions of these schools of thought.

This study was conducted to analyze the impact of the budget deficit on key macroeconomic variables in the seven major industrial countries (G-7): Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. Four models were developed to test the impact of the budget deficit on the variables of importance within the economies of the countries in question. The first model tested the relationship between the budget deficit and the short-term interest rate. The second explored the impact of the budget deficit on the long-term interest rate. The third model examined the impact of the budget deficit on the trade balance. The fourth and final model was specified to explain the relationship between the budget deficit and economic growth. The data utilized in this study covered the period from 1964 to 1993 and were gathered mainly from the international statistics of the International Monetary Fund. The data were standardized in the form of the percentage of the gross domestic product and the percentage change over the previous year in order to compile similar data across the seven countries. Multiple regression analysis as well as meta analysis were used to analyze the data. The multiple regression results indicated that the budget deficit leads to higher short-term interest rates in Japan and the United States. With respect to the long term-interest rate, the budget deficit led to an increase of this rate in France, Germany, and the United States. The budget deficit, however, appeared to worsen the trade balance in Canada. In Italy and the U.S., the trade balance improved with the budget deficit. With respect to the economic growth, the budget deficit is a significant variable of growth in France, Germany, and Italy. When the data for the seven countries were combined in meta analysis, the results showed that the budget deficit led to higher short-term interest rates in the seven countries. The budget deficit, however, did not manifest any impact on the long-term interest rates. The trade balance was worsened by the budget deficit and the economic growth improved in all the seven major industrial countries.