According to previous findings about
the impact of budget deficits on the developing economies, it was found that:
- The budget deficits are unambiguously bad for economic growth.
- High budget deficits are mostly explained as consequence of planned political decisions and not as consequences of external shocks or reaction on current internal economic situations.
- Although short term budget deficits financing by demonetization doesn’t necessarily lead to inflation, in long term horizon, demonetization causes inflation growth.
- There is some evidence that public investments are not always positive investments, which denies the general opinion on the question. The public investments have negative effects on private investments. Public investments replace rather than complement private investment.
- A budget deficit causes current account deficit and overvaluation of the exchange rate. This makes another negative impact on economic growth and also leads to decrease in exports.
- Reducing budget deficits is an effective policy measure in raising national savings.
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Agu (1988) reviewed IMF journal on the effect of budget deficit on GDP to ascertain the determinants of macroeconomic volatility and its implications on economic growth in Nigeria. He noted the existence of trade imbalance and negative real interest rate during most of the review period (1970-1985). He demonstrated the negative effect of budget deficit on GDP over time using Mckinnon financial repression diagram. His main conclusion was that the relationship between budget deficit and macro economic aggregates is a dual sign that is some are negatively related while some are positively related to fiscal deficit.
Lansing (2001) evaluates the impact
of budget deficit on economic performance. It discusses the theoretical
arguments, reviews the international evidence, highlights the latest academic
research, cites examples of countries that have significantly improved their
share of national economic output, owing to controlled deficits and analysed
the economic consequences of these reforms. The conclusion was that fiscal
deficit exerts negative relationship with macroeconomic variables like savings
through interest rate and hence retards growth.
Nwodo (2001) analyzed the long-run
effect of budget deficit on economic growth of Nigeria for the first half of
the 1990s. the main findings was that budget deficit did matter, but only to
the extent it contributed to the money growth and of not checked, induces
inflation, hence, leading to a distorted economy. As most of the budget
imbalance was being monetized during that period, it is no surprise that
independent influence of the budget deficit on the GDP growth was not found.
The conventional wisdom about
deficit crowding our private investment is strongly reaffirmed by the studies
conducted by world observers using case studies of 10 countries. According to
the observer, the private credit in high deficit financially repressed
economies have event worsen effects than the increase in interest rate in high
deficits. In unrepressed economies, the quality of investment was empirically
confirmed in countries as diverse as Argentine, Cote d’Ivore and Thailand.
Further studies conducted that deficits due to high public investment are less
harmful. In some countries, the effect of public or private investment is
positive; for example, Morocco, Pakistan, Thailand and Zimbabwe, while in countries
in Chile, Columbia, Ghana, Mexico, it is negative. However, what matters most
is the type of government and investment, if public partially compliments
privates’ capital, greater private capital formation is likely.
Dervis and
Patri (1993); Borinton, Jones and Kigue (1984); Fisher (1993); Ghura and
Grennes (1993); Goldbrough et al (1996); Schmidt-Hebbel (1996); Lenisk K.
(1996); Calamistris, B and Ghura (1999); they argued that macroeconomic
stability has a variety of internal and external causes, its primary sources
throughout Africa and other less developed countries have been persistent
public sector deficits financed by money creation which resulted to high and
rising inflation, unserviceable level of external debt, stagnant and declining
real income, capita; flight, currency substitution and unstable exchange rates.
Arize and Malindretos
(2008) try to investigate the relationship between trade deficits and the
budget deficit for ten African countries using popular time series
methodologies. In determining the casual relationship between the trade deficit
and the budget deficit using error-correction model found a bi-directional
long-run causality between the budget deficit and the trade deficits. Their
result shed light on the nature of the relationship between the trade deficit
and the budget deficit in these developing countries and suggest that balancing
the budget cannot be expected to reduce the trade deficits; however, what is
needed are both fiscal and monetary polices. In addition, the result suggest
that government policy actions aimed at reducing trade and budget deficits can
generate at best only uncertain results if the initial focus is not placed on
policies that attempt to reduce the trade deficits.
According
to Omoke and Oruka (2010), who employed Pair Wise Granger causality Test in an
attempt to offer evident on the causal long term relationship between budget
deficit, money growth and inflation in Nigeria, considering the broadest
definition of money supply, found that money supple causes budget deficit which
means that the level of money supply in the Nigerian economy will determine
whether there has been or there will be budget deficits. Inflation and budget
deficit revealed a bilateral or feedback causality proving that the changes
that occur in inflation could be explain by its own lag and also the lag values
of budget deficit and in the same vein, changes that occur in budget deficits
are explained by its lagged values and the lagged values of inflation. The
implication of their findings is that both budget deficit and inflation could
be caused by money, supply meaning that they are both monetary phenomena and
also, inflation is also caused and found to be dependent on the performance of
the budget.
According
to Ben (2010), larger budget deficit has adverse effect on the economy because
it tends to reduce national saving, which in turn reduces domestic investment
and increases borrowing from board, besides, a low level of national savings
rises inflation and domestic interest rates and crowds’ private sector
investment. The reduction in investment in turn affects employment as firms or
business reduces their demand for labour and other factor inputs. All of these
reduce national output, which in turn lead to trade deficits and balance of
payments and reduction in the overall well-being of the people.
Obi and
Abu (2009), explains that fiscal deficits and government debt have positive
impact on interest rates, but inflation and international trade were found to
have negative effect on interest rates. In their study using vector
autoregressive model and covering a period of 1985-2006 suggested that deficit
financing leads to a huge debt stock and tends to crowd our private sector
investment, by reducing the access of investors to adequate funds, thereby
raising interest (and/or lending) rates. The rise in interest rate reduces
investment demand and output of goods and services. These in turn reduce
national income as well as employment rate, and the overall welfare of the
people would decline. Thus, government should make efforts to reduce
unnecessary spending because experience has shown that a large proportion of government
expenditures have been channelled to unproductive ventures.
Abdul and
Naeem (2008) critically analysed short-term effect of budget deficit on money
supply, private and public investment and output, balance of payment,
international reserves and unemployment. Using an annual data of Pakistan for
the period of 1960-2005 and adopting error Correction Mechanism (ECM), the study
revealed that short run changes in money supply is positively related to
changes in foreign reserves. The short run changes in money demand are
positively related to short run changes in income. The short run changes in
output is positively related to short run changes in consumption expenditures,
private investment, public investment and balance of trade. It is negatively
related to short-run changes in real rate of interest. Short-run changes in
private and public investment are positively related to short run changes in
output. Short run changes in export is positively related to short run changes
in output, relative prices of export and exchange rate. Short run changes in
import are negatively related to short run change in exchange rate. Short run
change in unemployment is negatively related to short run changes in output
growth (GDP). Based on their findings, they recommend that long term private
and public investment policies can gain better result in economic growth.
Takero,
Toshihiro and Hiroki (2002) argues using Japan as a case study, that when the
government debt becomes large and political leadership is weak, it would be
much difficult to induce all interest groups to cooperate. They found that with
larger deadweight loss of lobbying activities, higher existing privileges and
higher government debt are made relative to the benchmark case without
deadweight loss. Raising taxes cannot necessarily alleviate the fiscal crisis
compared with the benchmark case. Its negative income effect is to enlarge
group-specific public works and transfers, resulting in a bigger size of
government without reducing government deficits much. This is one of the main
reasons why fiscal reconstruction was not completed well in Japan. In order to
realize successful fiscal reconstruction, therefore, they need the strong
political leadership and efficient decision process. This could lead to an
interesting international comparison of fiscal stabilization policy in the real
world to cope with budget deficits.
Alessandro
(1999) studies the effect of a temporary budget deficit which is financed in
the international capital market on the exchange rate. He found that the
exchange rate depreciates both in the short and in the long run if the government
finances the deficit by selling debt denominated in foreign currencies to non-residents.
The governments of many small industrial countries have both financed budget
deficits in the international market and changed the currency composition of
the outstanding debt. In the study, he argued that these debt management
policies cannot prevent the real exchange rate from depreciation in the long
run, even though, theoretically, governments can temporarily achieve their
exchange targets. In practice, however, the size of official external borrowing
and intervention that is needed to maintain the exchange rate even for a short
period of time may be feasible because countries may be rationed in the
international capital market when their external debt grows rapidly and
expectations of a long-run depreciation are sufficiently strong.
Masayab
and Ali (2009) examine the relationship between budget deficit and current
account deficits in the Philippines using time series data for the period of
1970-2005. They utilized Toda and Yamatoto procedure in order to determine the
direction of causality between budget deficit and current account deficits.
Their empirical results give further support to the Keynesian view that there
is a strong link between budget deficits and current account deficits in the
Philippines. The results of Roda and Yamamotos’ causality analysis supported
the existence of bi-directional causality between budget deficits and current
account in the Philippines.
Therefore,
appropriate measures to reduce budget deficits could play an important role in
reducing the current account deficits and vice versa. Also, there are other
important factors such as improving the terms of trade; coordination of
monetary and fiscal polices; a sustained effort to enhance private saving;
measures focusing on efficiency improvement as well as the exchange rate, which
will complement the budget cut policy.
Mamodouh
(2000) analyses the relationship between budget deficit and trade deficit in
petroleum economy, by taking the case of Saudi Arabia as an example. Using
animal time series data covering the period of 1970-1999, he analyzed the
theoretical framework based on the two hypotheses; the Ricardian equivalence
neglects any relationship between the two deficits and the Keynesian
proposition confirms the existence of a positive relationship between them. Because
of the special characters of the petroleum economy, they tried to argue that
any of the two hypotheses is not valid in their economy. Considering the
important role of oil revenue of the components of trade accounts and the
public budget, they expected a positive relationship among budget deficit and
trade deficit, but the direction of the causality is reversed, trade deficits
causes’ budget deficit. From their findings, if the government would like to
reduce trade and budget deficits, the government must begin by reducing trade
deficit. Since the trade deficit depends on oil prices, the government has to
diversity the sources of national income. Also, when the oil revenue becomes
less important in domestic income, the structural economic transformation may
reverse the causality direction between the deficits, and the Keynesian
proposition will be more valid.
Using a
variety of indicators of Central Bank independence in Columbia, Sikken and Haan
(1998) found analogous outcomes for a group of 30 developing countries.
Basically, they tested whether such independence affect monetization of the
deficit. They concluded that there is no relationship between their Central
Bank independence and the budget deficit level. Other findings that show fiscal
deficit does not contributed significantly to money growth and inflation are
reported by Protopapadakis and Siegel (1987) for samples that include developed
economies and by De Haan and Zelhort (1990) for developing countries.
Yaya
(2010) employed the Granger-causality test developed by Toda and Yamatoto
(1995) using a sample of seven West African countries namely; Benin, Burkian Faso,
Cote d’ Ivoire, Mali, Niger, Senegal and Toto. In order to examine the causal relationship
between budget deficits and economic growth in these countries and covering a
period of 26 years, found out that in three cases, there was no causality
between budget deficits and economic growth. The above findings indicate
two-way causality in three countries, deficits having adverse effects on
growth. Overall, these results give support to the WAEMU budgetary rule aiming
at restricting the size of budget deficit as a prerequisite for sustainable
growth and real convergence. In four other countries, there was causality
evidence between budget deficit and economic growth implying that deficits
retard economic growth rate. These findings have two main implications. First,
they lend support to the control of budget deficits within the West African
Economic and Monetary Union countries and in order to increase domestic savings
and finance economic growth. Second, evidence of causality running from
economic growth to deficit makes difficult the control of the size of the
budget deficit as to depend on the aggregate economic health. In periods of
recession, revenues are expected to decrease, generating fiscal imbalance. In
periods of expansion, revenues increases that leads to reduction in the size of
deficit.
The World
Bank (1993) opined that in economies where financial markets are not repressed,
higher deficits financed by domestic debt increase real interest rates when
external borrowing is not possible. However, if financial markets are
integrated with world capital markets, higher domestic borrowing results in
international capital inflows and high foreign debt. Thus, the impact on
domestic real interest rates will not be much. Moreover, in counties where the
financial markets are repressed (that is interest rate control, compulsory
public debt placements and controls on external capital flows), given a fixed
nominal interest rates fiscal deficits raises inflation resulting in a
repressed (even negative) real interest rates.
Jean and
Tahsin (2002) explain that the effects of trade openness on budget balance is
through is effects on the instability of government. Governments are often
resistant to liberalize their trade regimes. Their argument is that the budget
situation is really difficult in developing countries and a liberalization
program will lead to larger budget deficits.
Finally,
it would suffice to mention that Lansing (2010) intimates that budget deficit
exerts negative relationship with macroeconomic variables like savings through
interest rate and hence retards growth. Also, Nwodo (2001) explain that budget
deficit did matter, but only to the extent it contributes to the money growth
and if not checked induces inflation, hence, leading to a distorted economy.
READ RELATED TOPICS ON
DEFICIT BUDGET
SUMMARY, CONCLUSION AND
RECOMMENDATION OF BUDGET DEFICIT
METHODOLOGY OF BUDGET
DEFICIT (TECHNIQUES, MODEL, STATISTICAL DATA