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The budget deficit and interest rate fluctuation - Literature review

Ari Aisen and David Hauner in their research (Budget Deficits and Interest Rates: A Fresh Perspective, 2008) explain that there is an on – going relationship between the budget deficit and interest rate fluctuation that an economy bears due it. It is claimed that there is a a highly positive relationship present in the interest rate hiking and the presence of the fiscal and monetary deficits in the economy. It is explained in the research that deficits in an economy is most of the times financed by domestic resources by various sources including printing more money by the Central bank, raising debt from commercial banks. This creates auxiliary problems including interest rate swings, low financial openness with low financial depth in the economical makeup. It is enlighten by the researchers that in United States, there are several studies conducted which gives a high indication of negative consequences of deficits on interest rates. It was further concluded that the impact of budget deficit on interest rates is around 26 basis points per percent of Gross Domestic Product. On the other hand, these consequences varies from country to country where end product of budget deficit in interest rate fluctuations is based upon interference tenure is noteworthy below one of the following stipulations which include high deficits, more often than not nationally financed and interrelate by means of high domestic debt, monetary openness is low down, interest tariff are loosen where financial intensity is said to be low where domestic financial sector is said to be less developed. These factors carry much weightage in terms of policy insinuation predominantly about the efficiency of fiscal policies and the way taxes are generated, expenses are made and keeping an efficient cycle running in the economic set – up . The researchers also explains that for a successful fiscal policy to be maintained in the system, it is easily possible only when the preliminary budgetary deficits are on the low side and financial back of the economic system is on the higher side in order to be used as a helping hand providing cushion to the financial deficits. It is further suggested by the researchers that deficit financing is the worst thing if there are no appropriate policies present in the economical structure, since these are the policies which sketches the framework of economic growth and financial stability. In the absence of adequate policies and altering interest rates, it is barely impossible for the economy to revive a healthy and growing status.

Mieczysław Dobija in his research paper (Economy Sentenced for Growing Budget Deficit versus the Balanced by Labor Self Financing) discuses that the most appropriate mode of finance the budge and financial deficit is using the phenomenon of Human Labor which can lead positively and successfully to the self financing. At the time, the reward paid in the public sector is originated from the funds generated through taxes. It is another known fact that hiking budget deficits also disturbs the monetary policies that are made by the Central banks. The major question that the researcher questioned is what are the factors which have contributed in not allowing the young generations to take active part in financing the deficits as they do not get jobs. He also raised the important problem where economies face different problems in searching for permanent solutions for successful economical activities in order to support the fiscal and monetary deficits. It is known to every one that average rate at which growth of capital personified n the physical, natural and physical resources is around 8% per annum. Many of the economists argues that in most of the known Under developed countries, this percentage of using the human capital in the process of equipping them in such a way that it become mutually productive for them selves as well as the economy where it faces serious threats of fiscal and monetary threats. The researchers argue that this will help in alleviating the poverty, increase the wealth distribution, and equip a person to take a productive part in the system which in the end provides something which he can contribute to the Gross Domestic Product. The researcher stresses on the policy making which should help utilizing the most abundant and free of cost source of financing in financing the financial deficit. The research also focused on how central banks can play its important part in order to gain advantage of the human capital in the self financing phenomenon. The said phenomenon is said to be the easiest and successful advancement that ought to be achieved as the sole benchmark of originating the money. The researcher also explains that other criteria are improper to be used since they oppose the very basic laws of reality and energy conservation, which produces other side effects in the economical system including unemployment, inflation and an over all poor economic progress. It is suggested that human capital is to be made more powerful so that it could help the economy and the individual well – being for better present and future.

Jacek Cukrowski in his research (Financing the Deficit of the State Budget by National Bank of Georgia, 2000) the concept of total gross seigniorage which is used to investigate the foundation of revenues of The National Bank of Georgia and the way it was distributed. Detailed calculations were done by the researcher in order to compute the seigniorage revenues, its sources and uses and are deeply analyzed. It was also explained in the research that National Bank of Georgia has not based itself in financing the deficit through money supply in to the system but it worked on reducing the debt taken on non – governmental basis hold by the Central Bank of Georgia. It was observed by the researcher that the International and domestic stock of assets were hold by National Bank of Georgia, so in the long run the bank cannot base on it solely. So, in the future National Bank of Georgia can largely finance its deficits of the state budget by using seigniorage on monetary terms. No matter it will bring a short – term growth in the monetary number but it will accompanied with, as suggested by the researcher, uncontrollable inflation and fluctuating interest rates. During the peiod of 1992-1993, Gross Domestic Product of Georgia had fallen by 70% due to break – down of Soviet Union, and the whole economy was trapped into a economic downfall. The government was not able to generate revenues from taxes which further created wide financial deficits in every aspect of the economy. This also caused the Georgian Government to raise funds from the world and started creating a pile of outstanding debt figures. At the same time, there were enormous monetary discharges caused hyper – inflation with a change of Consumer prices by 7488% in 1993. Dealing wqith the worst situation and financing the deficits, the government started the restructuring by the process of Intensive System Transformation. It was based on transiting to an economy and liberalizing it by having the state – owned sectors to be privatized in – order to generate revenue to finance the ongoing financial deficits, hyper – inflation, unemployment, low – tax base and intensification of macro – economic policies in order to give a muscle to the local currency and working on the wide – scale economic reforms in order to have a positive and successful out – look of the economy.

Jo˜ao L. M. Amador, in his research (Fiscal Policy and Budget Deficit Stability in a Continuous Time Stochastic Economy, 1999) explains that there is a great involvement of the role which the fiscal policies and rules of an economy play with a combination of the presence of budget deficit in the break down of economic growth. The research was conducted in a balanced model in which main focus was given to the integrating optimization of fiscal power and the public which pay the taxes. As a matter of fact, policies made on fiscal grounds and budget deficits have been a controversy and research question for every economy of the world. The research tried to develop the relationship between budget deficits and the conditions required to keep away from inappropriate road of public debt to take. It was also suggested in the research that fiscal restrictions and limitations are to be formulated keeping in view the macro economical presentation of the country. It is clear that a country has to look for immediate sources of finance in order to decrease the gap of deficits in the economy other wise it will moreover defaulted facing severe crash in economic growth or look for modes of financing which will be paid by the next generations in the form of unavoidable taxes and other state imposed laws. The research paper also gives weight to the changing tax rate and the public spending behavior which causes immediate budget deficit in the economy. These bring problems in Gross Domestic Product which is to be cushioned by additional numbers of capital to be raised by different resources present inside and out side the economy. On the other hand, it is exposed that the motionless stability in economies having near to the ground tax rates and high public expenditure has to be coupled with a low public debt-wealth ratio and a low budget discrepancy. The same is true for financial systems facing a far above the ground volatility on technology and spending distress and suffering. As a substance of fact, there should be appropriate and suitable workings to be done in calculating the deficit financing and the appropriate modes which are to be contacted to fill the gap of the deficit since this factor explains the economic path which the economy will take for the future it is entering to.

Rituparna Das (2005) in his research Law and Economics of Fiscal Deficit in India - 1998-99 to 2004-05 explains the financial problems in the Indian economical structure where there is enormous and immense poverty headcount and there is a constant fiscal and monetary deficit. It is explained by the researcher that the Indian Central Bank, The Reserve Bank of India deal with this problem in a most unsuitable way: It increases the money supply most of the times to finance the prevailing fiscal deficit in the short term, but for the long run it always stimulate inflation and unemployment but liberalization of the economical arrangement has counterbalance such worse inflationary possibilities. The research paper talked about the authority and weight of deficit financing in the prescribed manner where money supply become almost zero during the post restructuring phase where foreign exchange asset erupted as a strong and well – built factor of the money supply in the economy. The Reserve Bank of India proved a close relationship in the money supply and the Central Budget Deficit in their economic transactions which is a strong variable if inflation and poverty and unemployment come to question. In the Indian Economy, it was argued that over three decades, Central Bank Deficit is known to be the sole principal factor of money stock. As mentioned, Indian economy majorly focused on Foreign exchange assets in terms of exchange earning through tourism etc to finance their deficits in Central Budget which greatly prejudiced the money supply and velocity of money injected into the economy. It was argued that the elasticity of the money supply in 80’s in contrast to the Central Budget Deficit was said to be more than 85% where as for the same period, the said elasticity if compared to other numerous variables as foreign exchange assets is said to be -7, commercial bank credits being 40%, foreign exchange earnings and other assets its claimed to be in the same pattern. So it is clear that In economy focused on money supply to deal with the short run financial deficits in the earlier times but there is a paradigm shift in the economical policies of the Indian Central bank where it majorly works on increasing foreign earning rather than taking loans to finance fiscal loop-holes. This relation has been working for the Indian economy in good way, since Gross Domestic Product of Indian is competing with many of the developed countries of the globe.

New Evidence on the Interest Rate Effects of Budget Deficits and Debt, written by Thomas Laubach explains that there are many problems aroused due to the fluctuating real interest rates on the effectiveness of governments borrowed loans due to the deficits they face. It was also explained that there are different answers on different questions regarding any government’s behavior to the deficits in terms of changes in expenditure pattern or raising more revenues out of the taxes from the people. But as a matter of fact, Governments decisions on expenditures or generating revenues always impacts on the interest rates which further creates problems for the already damaged economy. The paper’s spotlight is determining the association between the interest rates and any breakdown in the fiscal up-and-down and deficits. In reality, deficits and fluctuating interest rates in an economy marks long – term impacts on the over all economical structure. This slows down the economic growth if the deficit is covered by any of the modes available other than the government it self. As mentioned, deficits causes fluctuating interest, which causes money borrowing difficult for businesses constituently causing unemployment and inflation. Again debt to Gross Domestic Product ratio is the crux of determining the overall economic growth of the country. Lower the debt – to GDP ratio, more is the economic growth as a result of narrow fiscal deficits. The study demonstrated that on statistical grounds and reasonable estimates on economic view, the effects of deficits form government’s side and grip on interest rates can be getting hold of by making long – term forecasts of deficits, debts and the interest rates that can get fluctuations as center of attention. On the other hand, there should be ample steps taken to ensure the after – effects of fiscal deficits and financing it through other mediums in terms of interest rates directly hitting the whole economic and business structure. All else equal, the results of this study proposes that interest rates rise by about 25 basis points in response to a percentage point increase in the projected deficit-to-GDP ratio, and by about 4 basis points in response to a percentage point increase in the projected debt-to-GDP ratio.

Jo˜ao L. M. Amador in his research (Optimal Budget Deficit Rules, 1999) explains the fact that fiscal establishment always wants to keep the budget deficit as low as possible. It is assumed by the researchers that the Fiscal authorities reduce the expected cut-rate worth of squared divergence from the reference values. The paper concludes that in the episode of proportional interference costs, the most favorable ceiling depends absolutely on the cost limitation and on the variance of the budget shortfall. It was also concluded in the study that the economies where there are higher rates at which taxes are levied and public expenditures are on the lower side, such economies must set budget shortfall ceilings on the highest side. The same applies for the economies with a fluctuating discrepancy on technological aspects and shocks on public expenditure side. As a matter of fact, it is suggested that its is the public debt that always took center of attention from the policy making side and fiscal set – up in terms of financing the budgetary deficit. It is also argued at many times that there is a high probability of inappropriate and inapt budget deficit performance which could erupt due to sudden alteration in economical structure for example hiking public expenditure, hiking tax rates and other monetary shocks which an economy can face in financing its budget deficits. Such episodes are more probable where there is a presence of Monetary Unions such as the European Union in the Europe. In such cases, it is observed that the central banks are seen to be low inflation oriented and are more independent making is more difficult to finance for deficits. It is obvious that an individual country cannot issue new money to finance its deficit situation due to the presence of Economic Union where Euro is the standard currency to be used. Consequently the single country cannot decrease the real value of the debt taken publically through surprise the inflationary fright and distress in the economy. This makes it much difficult for an individual country to finance its fiscal and monetary deficits by increasing velocity of money. In an other sense, this is an appropriate ceiling since printing money welcomes inflation and other inappropriate factors which in the end are persistent and difficult to handle.

Muhammad Nadeem Hanif in his research (Restructuring of Financial Sector in Pakistan, 2003) discusses in his research about the need of restructuring the Financial arena of Pakistan which is under debt lumber from International Monetary Funds, The World Bank etc as multilateral sources and many of the developed countries including United States, Great Britain, France, Australia, Japan etc as bilateral sources of external funds due to persistent economic deficits in the country for more than last four decades. It was argued by the researcher that financial sector of Pakistan is endangered with poor transactions engaged in instruments of finance like capital, foreign exchange, inflation, fluctuating interest rates and broad money. There is an overall fiscal deficit in the country for over forty years which has distorted the economic growth by every means. Pakistan has had many episodes of restructuring its financial situation at many points in time. In late 80’s Pakistan contacted International Monetary Fund and The World Bank for converging its massively wide fiscal deficits, taking 150 Million US Dollars in 1989 and 200 Million Dollars in 1997 from The World Bank. Asian Development Bank also provided with loans to Pakistan to provide a helping hand in the wide scale restructuring efforts on financial grounds. The restructuring efforts in Pakistan focused on two aspects, first being equipping financial institution with a self – surviving power and developing powerful financial markets. Many options were considered as relevant modes of financing including Privatization of many of the Government owned bodies including Pakistan Telecommunication Authority, Pakistan Steel Mills, Allied Bank, Muslim Commercial Bank etc. On the other hand, interest rates were also to be restructured under three broad dimensions including debt owned by public, concessional rates and caps on deposits and lending rates. To control the overall situation of financial deficits in the country, researcher also highlights the steps taken on administrative grounds in making a number of primary alterations in the monetary and credit management policies. Capital Market reforms were also necessity of time so that by giving investor an excellent atmosphere for investing, it will definitely help the financial and budget deficits in terms of taxes the government will generate out of the investment injected by the investors into the system. Researcher also explained the reforms made in the External sector which helped in the liberalization of exchange rate payments and earning foreign exchange earnings. Acceptance of obligations of Article-VIII, Sections 2, 3 and 4 of the IMF Articles of Agreement which made it possible for Pakistani Rupee to be convertible on current international dealings. All the steps were taken to help Pakistan’s economy get a helping hand in the persisting worst situation on financial bases and despite of taking external help, reforms were tried to be introduced for successful economic growth.

Jonathan Baron (Starving the beast: The psychology of budget deficits, 2005) clarify in his research that the world today has to follow the policy of ‘straving – the– beast’ in which taxes should be cut at the time being so that it should be anticipated that it will in return it will cut the spending in the next time. It was suggested that there should be a cut in both expenditure done by the governments and levels of taxes it raises from the public. It is also discussed in the research that this is the best idea to avoid any fiscal or over all deficit in an economy and if there is an occurrence of deficit in the economic indicators. It will not only show a slow growth at which economy runs but also accompanies various other socio – economic, political and social problems where different social oriented products are cut with spending and there comes a narrow road on which the whole economy travels for many years. The researcher and his subject conducted different surveys and questionnaires in the US finding about the expenditures and the deficits which the government faces. The research ends with the main idea that how the policy of straving – the– beast’ might get success. The main idea which was presented to successfully launch the policy is achieve tax – cuts in the present with a decline in over all spending in the country. If the spotlight is given just to cut taxes, not equally on controlling the expenditures and controlling negative payments, it will end with a budget deficit. Once this deficit is there in the economical structure, it was suggested by the researcher that there should be careful steps to be taken as the deficit financing is either done by a combination of raising tax rates and cutting expenses and consulting any other modes of finance which will definitely creates more problem for the government and widens the fiscal deficit. It was also concluded that the research done on the people on the subject matter explains that there is a strong desire among them to cut specific taxes and expenses where it is obvious that this will not bring the deficit to zero, but will somehow gives help to the overall deficit and negative numbers. The researcher also argued that there should be ample legislations passed in the financial policies of a country benchmarking the taxes and spending and also including laws for financing from other resources, as financing from various sources or any of the source which is not suitable for the economic conditions of any country. For example, the terms and conditionality put by International Monetary Funds are not suitable for many countries and their economic growth for an average of three decades, for most of the countries like Pakistan, Ecuador, and Bangladesh etc

Michael Br¨auninger explains in his Research ,The Budget Deficit, Public Debt and Endogenous Growth that government of any particular country plays an important role in determining the deficit ratio regarding to budget break down. It is obvious that a drastic increase in the budget deficit ratio reduces that growth rate of any country, and to cover the difference, it has to look for financing after choosing any source out of many. In any economic and financial policy making, two major concerns shown by the officials are regarding the debt which is to be borne by the people at last and the economic growth which the economy gets after taking the borrowings. As a matter of fact, most of the OECD countries have been piling up debt with increased budget deficits consequently widening Debt/GDP numbers. This is quite an alarming situation where a country like Japan is also showing a double Debt/GDP ratio during the last decade of century. Situation from Germany quite resembles which has caused many deficits in the budgets of the two countries in many years due to larger debt to Gross Domestic Product’s ratio. All of a sudden, there was an episode of economic expansion turn down in both the countries. The research paper majorly focuses on the budget deficits that are erupted due to taking various debts and the impact which the economy gets out of it. It was also discussed by the author that in contrast of budgetary deficits, government can control it by having a sharp eye on the tax rate as a source of revenue, by controlling budgetary deficit ratio and purchase ratios for the government. On the other hand, government is left with minimum options which are even more difficult to control, increasing the taxes or controlling debt to gross domestic ratio. Therefore, it is much important for a country to have a constant check on its deficit ratio for strong growth and raising Gross Domestic Products. There are many modes to finance for the budget deficits, internal and external both, but it was argued by the researcher that if the situation is controlled well in time, there are higher chances of having enormous growth. How so ever, it there is a need of borrowing, there should be some yardsticks and criteria set in terms of debt/GDP ratios and the tax rate that is to be followed by it.

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