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Why the US Economy Could See a Higher Deficit

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Understanding the US budget deficit

A government budget deficit occurs when an economy’s annual revenue is less than its total expenditure. For fiscal 2019, the US Congressional Budget Office estimates the US budget deficit at $985 billion, where the expected revenue stands at $3.422 trillion while the budgeted expenditure was $4.407 trillion. The government spending is divided into mandatory and discretionary spending. Mandatory spending includes social security and Medicare, and discretionary spending includes military spending, health services, education, housing and urban development. The US economy has had a budget deficit since 2002, when the US “War on Terror” began, and the deficit has been increasing every year, currently standing at $20 trillion.

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How the budget deficit impacts the economy

In the short run, the budget deficit has some positive economic impacts. The problem is that it increased partly because of military spending, which doesn’t benefit the economy directly. Industries in the business of manufacturing defense goods (ITA) stand to benefit, but the cost is borne by taxpayers. Continued budget deficits increase the national debt, which in the long run weakens the US dollar (UUP) and increases interest rates on government securities (GOVT). This effect could lead to higher import costs and inflation, which could force the Fed to increase interest rates and mean a spiral of higher rates and inflation (TIP) that could weaken the economy.

How can a deficit be contained?

A straightforward solution would be to cut spending, but that isn’t an easy task. Successive governments have increased spending and failed to cut costs to help the economy grow. The problem with increasing deficits is that the US Treasury must borrow to fund the deficit by issuing short-term (SHY) and long-term debt. As more debt is issued, the interest that needs to be paid also adds to future deficits, creating a debt spiral that the economy needs to face. In the next part of this series, we’ll explain how US Treasury borrowings could rise.

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