Macroeconomics – Managing Public Debt

Managing Public Debt There are three ways to manage public debt. These budget philosophies are the Annually Balanced Budget, Cyclically Balanced Budget and Functional Finance. Each policy has its advantages and disadvantages which attempt to achieve a deficit during recession and move towards a surplus during inflation, which is the essence of counter cyclical fiscal policy. Based on a traditional orthodox view, the Annually Balanced Budget sees the government control its budget on a yearly basis, which is considered an advantage.

Balancing the budget on a yearly basis encounters many disadvantages including intensifying the business cycle and inflation. When the economy enters a period of rising unemployment, incomes will fall and tax receipts will diminish. For the government to balance its budget it must either increase tax rates or reduce government expenditure or provide a combination of the two. However the contractionary nature of the two means that instead of stimulating, aggregate expenditure will continue to decrease. When inflation is escalating, money incomes rise and so does tax collections.

The government will either increase government expenditure or decrease tax rates to avoid a surplus or provide a combination of the two. The Annually Balanced Budget can be seen as pro cyclical instead of counter cyclical, increasing the business cycle and inflation, placing pressure on the economy. It can be seen as not the best option for creating a healthy economy. The Cyclically Balanced Budget sees the government balancing the budget over the course of the business cycle, whilst exerting a counter cyclical influence.

The advantages of this policy include offsetting a depression; the government should lower taxes and increase spending to incur a deficit. Also within an inflationary period taxes should be raised, government spending cut to counteract the deficit gained during the recession. The disadvantages associated with the Cyclical Balanced Budget see the goal of stabilisation conflicting with balancing the budget over the cycle because the upswings and downswings of the business cycle may not be of equal magnitude and duration.

Additionally the periods of depression may be long and severe resulting in a large deficit which followed by a short “boom” period would result in little to no surplus, causing a cyclical deficit in the budget. Although the Cyclically Balanced Budget can be seen as a simple option, managing the economy with this policy would prove to be difficult because it’s difficult to predict recessions and boom periods and their length. The third and unorthodox philosophy Functional Finance sees the primary purpose of the government is the stabilisation of the economy, not balancing the budget.

The budget is referred to as an instrument for “achieving and maintaining macroeconomic stability”. The advantages of this option take into account the minor consequences of deficits and surpluses when compared to the alternatives of recession or inflation. The disadvantage of Functional Finance is the concern surrounding the large and growing public debt. Large debt can crowd out investment, which will therefore cause an increase in income disparity. The approach that would be best used in today’s modern economy would an integration of the philosophies of Functional Finance and Cyclically Balanced Budget.

Functional Finance sees stabilising of the economy its main focus rather than balancing the budget where as the Cyclically Balanced Budget is a public budget policy which concentrates on the management of the budget over the business cycle. By amending both the philosophies to avoid any disparities, and therefore creating a fourth philosophy this would best suit an economic situation similar to Australia. Bibliography: * Textbook: Jackson & Mclver ‘Macroeconomics Edition 8’ McGraw – Hill Pty Ltd 2007 . * Websites: * www. australianbudget. com/report * www. economist. com. info * www. 1800australia. com