The role of government in the U.S economy extends far beyond its activities as a regulator of specific industries or gatekeeping. The government is also responsible for managing the overall pace of economic activity, with its objective of maintaining high levels of employment and controlling price stability (inflation). It has two main tools for achieving these goals: fiscal policies, which is done through taxes and spending and monetary policies, through which it manages the supply of money. In this paper, I will discuss the why high deficits of today will reduce growth rate of the economy in the future, look at the history of our nation’s debt and deficits, different elements that causes of deficit and why the cause actually matters, what role the fiscal and monetary policies have to lead to higher or lower budget deficits and how deficits affect the overall long-term economic growth and debt of the U.S.
Let us first begin by learning the difference between the terms debt and deficit. In economics, the term deficit means a shortfall in revenue of a fiscal year. It is when the government’s revenue called receipts, which are collected taxes (payroll, corporate, excise, income and social insurance), fee revenues and tariffs that are called receipts are lower that what is spent called outlays. In other words, the federal budget deficit is the yearly amount by which spending exceeds revenue. The term debt is described as an accumulation of deficits so the national debt is the total amount of money owed by the government. It is calculated by adding all of the deficits minus the surpluses since the nation’s inception and you get the current national debt. According to Econintersect, “the estimated 2011 budget deficit is at almost $1.5 trillion, following deficits of $1.4 trillion in 2009 and $1.3 trillion in 2010.” ¶ 1. This is disturbing when measured as a percentage of the gross domestic product (GDP), it is 9.8% (2011), 8.9% (2010) and 10% (2009). As of today, the current national debt is 14.46 trillion dollars. To get an idea of how much debt we are discussing I will use an example provided by Coastline Financial Solutions “Let’s say you work 8 hours a day, 5 days a week, 50 weeks out of the year (you get a 2 week vacation) making $100,000 an hour. It would still take you 70,000 years to pay off the debt.” With the federal government borrowing that much from tax payers, it will be a very daunting and bleak economic future for the U.S if this continues. This correlates to the question of why deficits of today will reduce the growth rate of the economy in the future.
To make sound decisions in our present condition and economic future, we must first analyze and review the history of American debt. Understanding how the federal government creates its debt and how the deficit is incurred provides great information to comprehend its short and long-term effects on the economy. In this astronomical debt a new phenomenon for America or is it a reoccurring theme? Since its inception, the U.S has had public debt. The fiscal year from 1789 to 1842 began on January 1 so the beginning of the fiscal year of 1791; the national debt was recorded as $75,463,476.52. By 1816, the debt grew to $127,334,933.74 but then contracted to nearly zero in late 1834. In the beginning of 1835, we began our fiscal year at $33,733.05. Unfortunately, that was short-lived and by 1839 the national debt surpassed $10 million. In 1842, Congress changed the fiscal year from January 1 to July 1 which lasted until 1977. After the 2nd changed of the fiscal year, we began to see dramatic growth in our national debt due to the Civil War. President Abraham Lincoln was in need of money to fund the war and ordered Congress to pass a bill authorizing the printing of full legal tender treasury notes. This decision caused our debt to soar from $65 million in 1860 to over $1 billion in 1863. By 1865, our debt was at $2.7 billion. The national debt fluctuated between the 2-3 million for the remaining of the century however, due to our involvement in WWI our debt grew exponentially to $26 billion. By 1945, World War II marked another surged in the national debt to a whopping $260 billion. Since WWII, the debt's accumulation rose at a steady rate correlating to that of inflation until the 1980s, during Reganomics, when it began to skyrocket again. The U.S hit the $1 trillion mark in the fiscal year of 1982. It rose steadily until the Clinton Administration, where we witnessed a substantial budget surplus, however after the 9/11 attacks and our entrance into the Gulf War in 2002 we were back to enormous deficits toppling $6,228 billion. In 2008, the U.S entered what many called the “Great Recession” at $10 trillion and due to financial bailouts and stimulus package put in place to prevent the recession from becoming a depression; we are now sitting on 14.46 trillion worth of debt and counting.
As we can see, historically there have been a pattern of enormous surges in the deficits during and after war which leads us to the question does it matter whether the deficit is caused by lower taxes, increased defense spending or more job-training programs? In my opinion, deficit investment that promotes more economic growth, such as, investment directly in high technology development, health research, clean energy projects and further education is economically sound investments that will produce a good return that can directly affect. However, even though these items are on the agenda they do not seem to be a priority. Our national debt seems to grow exponentially for defense spending, which I do think is quite important, however having the most powerful military in the world does not do much when you are ranked number 18 in world for education, 37th in performance of healthcare, or 3rd in highest unemployment rate. I do not think the average American would have a problem if the government was creating debt as a result of implementing programs to decrease unemployment, improve healthcare and develop better infrastructure for our society. Unfortunately, the issue is the government is notorious for investing in programs that are self-serving and promotes personal political agendas which have a low/negative economic return. However, the major question is, should our focus be on just deficit reduction or what is causing the deficits? There are different types of deficits: cyclical and structural and each have different perspectives. According to Harrison, (2010), “from a cyclical perspective, a decrease in aggregate demand, will cause deficits. These deficits are the sum of the loss of labor and the economy not operating at its maximum its potential.” ¶ 4.
However, the structural perspective presents a different analysis of the deficit. A structural deficit will exist even when the economy is at the peak of the cycle. Harrison, (2010) describes this as “the structural induced deficit results from defense spending and social spending programs (Medicare, Medicaid and Social Security), non-discretionary spending. Lower tax revenues have an impact on the social spending programs.” Without increasing taxes, many predict a bleak future for government funded social program; up to a 40% reduction. In a recent address, Paul Krugman professor of Economics and Nobel Prize winner for Economics provides the predictions of economic impacts of the current low tax revenues: “If taxes stay as low as they are now, government as we know it cannot be maintained." He goes on to say "Social Security will have to become far less generous; Medicare will no longer be able to guarantee comprehensive medical care to older Americans; Medicaid will no longer provide basic medical care to the poor." In other words, the future generation may not be able to take advantage of government funded programs offered today as there will be not funds by the time they reach retirement age. In my opinion, in time of recession, the priority should be reducing unemployment and increasing productivity not the decreasing the deficit however there are many different philosophies on how to best create a successful economy. You have some who believes that less taxation from the government will increase individual buying power thus, causing business profits to rise. Others, like myself, believe that if the government invest our tax dollars in programs of societal enhancement then we be able to form a strong, stable economy that is less likely to collapse.
The government uses important tools like fiscal and monetary policies to stabilize and manage the macro economy. The aims of fiscal and monetary policies are similar in that they are both used to try to keep inflation low (price stability), maintain positive economic growth and aim for full employment. The primary function of both these policies is to reduce cyclical fluctuations in the economic cycle. How they differ is the route of which they take to maintain stability and who is authorize to issue it. According to Case et al, (2009) “Fiscal policy refers to the government’s decisions about how much to tax and spend.” (p. 95) It is an important tool for managing the economy because of its ability to affect the total amount of output produced, (GDP) gross domestic product. The fact that fiscal policies have the ability to affect the output of aggregate demand makes it a great tool for stabilization. Expansionary fiscal policies economy, by injecting money into the economy, can directly create jobs and increase economic activity. Many economist who believe in the Keynes theory will argued that an expansionary fiscal policy is necessary in a recession because private sector saving begins to rise rapidly due to loss of confidence in the system. Therefore, to regain this confidence, it is necessary for government borrowing, which will maintain a reasonable level of economic activity. However, the drawback to these policies is that it increases the budget deficit. Monetary policies are demand-side macroeconomic policies that are the responsibility of the Federal Reserve System, the nation’s central bank. They use three main instruments to manipulate the economy: OMO (open market operation), the discount rate and reserve requirement. Monetary policy is mainly used for ‘fine tuning’ the economy; making small changes and as a policy it has limitations. According to Tobin (2010), ”Monetary policy attempts to relieve those inconsistencies. An increase on aggregate spending on goods and services by consumers, government, and businesses is increased through expansionary monetary policy.” ¶ 3. So which one is more effective, as it relates to the budget deficits? Some economists argue that fiscal policies that promote budget deficits do more harm than good because they allegedly lead to higher interest rates. Since higher interest rates are believed to reduce investment which is necessary for long-run economic growth, supporters of this view (sometimes called "deficit hawks") proclaim that avoiding deficits should be the primary goal of fiscal policy not increasing it. While monetary policies, cut interest rates to try and stimulate borrowing, spending and investment. It should also weaken the exchange rate which will help exports however this policy by itself can be insufficient in severe cases. In severe recession or economic situations, combinations of both these policies are needed to stabilize the economy.
In essence we must ask ourselves, how do budget deficits affect overall long-term economic growth and the debt that the U.S. has to contend with? Government spending can affect long-term on economic growth. What is borrowed today must be repaid tomorrow. Unless considerable reforms are made soon, we as a country are in for a rude awakening. For ex: Once the baby boom generation begins to retire and collect their federal entitlements, our debt will explode and a substantial amount of our taxes will go to nothing but interest. Furthermore, at today's taxation levels, every dollar that is collected will be engulfed up by these entitlements and interest alone. Massive tax increases will be required just to pay for defense and national security and many other government services and programs. Our children and grandchildren will be left with the bill for our excesses and may have to create more spending to compensate the spending of today. So what is the answer? This an on-going debate that does not have a clear-cut simply answer. The only thing that is agreed on is that we need economic growth which is based on the growth of labor productivity and labor supply. However, increasing the economy's productivity rate often requires the application of something new whether its technology or resources and this can take many years or even decades to manifest. Many economists believe that money takes the role of energy in the first law of thermodynamics. It is neither created nor destroyed; just merely goes from one entity to another. In other words, every dollar Congress injects into the economy has a source. Unless it was newly printed or sitting in a vault, it was either money that was first taxed or borrowed from a foreign country. No new spending power is created. It is merely redistributed from one group of people to another.
In conclusion, we discussed why high deficits of today will reduce growth rate of the economy in the future, we took a glimpse into the past and saw how our national debt came into existence, we examined different elements that causes of deficits, discussed what role the fiscal and monetary policies play into budget deficits and how deficits affect the overall long-term economic growth and debt of the U.S. This is a long standing debate on what should be done but I can say if we do not do something fast about our ever-surmountable debt we may bankrupt ourselves soon.

References:

Anonymous. (2011, January 27). USA Budget Deficit for 2011 $1.5 trillion and Gets Worse In
Following Years. Global Economist Intersection .Retrieved on July 23, 2011 from

http://econintersect.com/b2evolution/blog1.php/2011/01/27/usa-budget-deficit-for-2011-1-5-trillion-and-gets-worse-in-following-years

Anonymous, (2011). Coastline Financial Solutions. Retrieved on July 23, 2011 from

http://www.coastlinefinancialsolutions.com/blg/521/what-does-14-trillion-look-like.html

Case, K., Fair, R., & Oster, S.(2009). Principles of Macroeconomics. (9th ed). New Jersey: Pearson/Prentice Hall.

Harrison, E (2010, October 7). Does focusing on deficit reduction reduce deficits?
Retrieved on July 25, 2011 from http://www.creditwritedowns.com/2010/10/does-focusing-on-deficit-reduction-reduce-deficits.html