Budget deficit – the excess of government spending over revenue; the main causes of government budget deficits include:
- Commitment to social welfare programmes
- Demographic trends
- Fundamental macro economic shifts eg slower growth in productivity, volatile inflation, increasing structural unemployment; together these factors have driven government revenues well below targets projected during budgets.
- Debt servicing obligation – when inflation is unstable, for instance, creditors lose money and become wary about future lending, either demanding higher interest rates to cover the added risk of inflation surprises or choosing not to lend at all. Because continued liquidity in the credit markets is vital to economic growth, governments cannot raise interest rates for any length of time without disrupting financial markets. The real growth rate also affects the accumulation of government debt. If an economy grows more slowly than the real interest rate, the national debt grows faster than the government’s ability to pay it back.
Inflation also raises payments for indexed benefits, since their levels are definition tied to inflation.
The problem is not that governments occasionally engage in deficit spending during recession or times of national emergency but that they do so continuously; what is crucial here is for developing countries to have budget deficits that are manageable and opportunity cost-effective.
Fiscal policy in developing countries faces unique challenges . Budgets are smaller, personal incomes are lower and tax collection is often erratic. Much employment occurs outside the formal economy, making transactions difficult to tax;
Financial markets in developing countries are often inefficient, making it hard for governments to do without budget deficits or even finance such deficits.