Balanced budget


Balanced budget

From a Keynesian point of view, a balanced budget in the public sector is achieved when the government has enough fiscal discipline to be able to equate the revenues with expenditure over the business cycles. In other words, a government's budget is balanced if its income is equal to its expenditure. This allows for a deficit in periods of low economic prospects that however needs to be matched by a surplus in periods of high economic activity.

Balanced Budget Multiplier

Because of the multiplier effect, it is possible to change aggregate demand (Y) keeping a balanced budget. The Government increases its expenditures (G), balancing it by an increase in taxes (T). Since only part of the money taken away from households would have actually been used in the economy, the change in consumption expenditure will be smaller than the change in taxes. Therefore the money which would have been saved by households is instead injected into the economy, itself becoming part of the multiplier process. In general, a change in the balanced budget will change aggregate demand by an amount equal to the change in spending.

Y_1 = c_0 + c_1 left ( Y - T ight ) + I + G

Y_1 = frac {1} {1 - c_1} left ( c_0 + I + G - c_1 T ight )

G = G + alpha ,

T = T + alpha ,

Y_2 = frac {1} {1 - c_1} left ( c_0 + I + left ( G + alpha ight ) - c_1 left ( T + alpha ight ) ight )

Delta Y = Y_2 - Y_1 = frac {alpha} {1 - c_1} left ( 1 - c_1 ight ) = alpha

Delta T - Delta G = alpha - alpha = 0 ,

A balanced budget occurs when the Federal deficit = $0. Taxes paid to the government = government spending. The government neither adds money to, nor subtracts money from, the economy. If state and local governments, businesses and private individuals do not add money to the economy, the total amount of money in the economy remains static.

When the total amount of money in the economy remains static, the smallest inflation reduces the "real" value of money in the economy. Example: Assume the total amount of money in an economy were $100 trillion and inflation were only 3%. If no new money were created via federal deficit spending, the total real value of federal money in the economy would fall $3 trillion.

After five years, the real value of federal money in the economy would be only $86 trillion -- a $14 trillion drop!

ee also

* Balanced Budget Amendment (United States government)
* [http://www.columbia.edu/dlc/wp/econ/vickrey.html Nobel prize Winner William Vickrey: Fatal fallacies of Balanced Budgets]


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