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Welcome to another forex education article by The Forex Koala!
Budget deficits issues are getting common of late and are responsible for economic crisis such as the Euro Zone Budget Deficit Crisis. So what exactly is a budget deficit? How does a country gets itself into such a situation?
In a nutshell, the management of a country’s financial health is not much different from a company or even yourself. Basically, total revenue should be minimally matched against spending to maintain a budget balance. Consider the following :
Government Revenue more than Government Spending =
Government Revenue less than Government Spending =
This is the basis of the management of a country ‘s financial health.
Revenue can come from sources such as taxation of personal income, businesses etc and also government business activities such as land sales, investments, etc.
Spending are often spend on social benefits such as unemployment handouts, medical subsidies for the needy and basic infrastructure such as roads, rails, power and more.
When a country spends more than it receives, financial reserves are used up. If there are no reserves, the country goes into debt, issuing bonds to borrow money. During times of economic uncertainty, the situation gets complicated with the reduction of tax revenue due to economy showdown and increased spending due to unemployment handouts and more. Furthermore lenders will probably demand more in the form of interests from bonds issuance, thus further exacerbating the situation. This is a dangerous scenario to get into and it can become a vicious cycle. Greece, Ireland, Portugal and Spain are examples.
Solutions are likewise simple but difficult to implement. Austerity cuts is the process of reducing spending in order to reduce the budget deficit and aim for eventual budget surplus. This is often meet with social issues such as strikes as this often has a direct impact on salaries and pensions. With reduced spending, many economists urge the viability of this solution in times of an economic slow down.
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