Chapter 17: Problem 41

In a booming economy, is the federal government more likely to run surpluses or deficits? What are the various factors at play?

Short Answer

Expert verified

In a booming economy, the federal government is more likely to run surpluses due to increased tax revenue from higher employment and incomes, and potentially reduced spending on welfare programs. However, this depends on various factors and policy decisions. A robust economy may also lead to higher interest rates, limiting borrowing and encouraging the government to avoid excessive debt. Overall, it is plausible for surpluses to be more common in a booming economy, but a definitive answer depends on specific circumstances and government actions.

Step by step solution

1. Understanding surpluses and deficits

In the context of the federal government budget, a surplus occurs when government revenues (such as taxes and fees) exceed government spending. A deficit, on the other hand, occurs when government spending is greater than revenues. It is essential to analyze how a booming economy influences both revenue and spending to determine whether surpluses or deficits are more likely.

2. Impact of a booming economy on revenue

In a booming economy, employment rises, and incomes tend to be higher. As a result, tax revenue from income taxes and other sources, such as consumption taxes, generally increases. Corporate profits are also likely to increase during favorable economic conditions, leading to more revenue from corporate taxes. Therefore, during a booming economy, it is reasonable to expect that government revenues will increase.

3. Impact of a booming economy on government spending

On the spending side, a booming economy may lead to less demand for certain types of government spending, such as welfare, unemployment benefits, and other social assistance programs. This is because more people are employed and able to provide for themselves in a robust economy. However, the government may increase spending on other items, such as infrastructure and public investments that can further support economic growth. Overall, the impact on government spending depends on various factors and policy decisions.

4. Considering borrowing and interest rates

In a booming economy, interest rates may rise due to increasing demand for credit. This can impact the government's ability to borrow money at affordable rates. If interest rates are high, the government may want to limit borrowing and avoid accumulating excessive debt. This, combined with the rise in revenues, can push the budget toward a surplus.

5. Conclusion: Surpluses or deficits in a booming economy?

There is no definitive answer to whether the federal government is more likely to run surpluses or deficits in a booming economy, as this depends on various factors and policy decisions. However, the economic growth generally increases tax revenue while potentially reducing the need for certain types of government spending. When combined with considerations regarding borrowing, it may be more likely for the government to experience surpluses in a booming economy.