Budget Deficits & Public Debt: Lessons for Economies in Transition

Are budget deficits bad for an economy? This question has perplexed economists for centuries. Historically, three schools of thought have emerged on this matter. One school takes the position that deficits have adverse influence on inflation, interest rates and private investment. As yearly borrowings to finance budget deficits accumulate into the stock of national debt, interest payments on such debt increase the burden of taxation and have inequitable distributional consequences. Second, suggest that deficits can be employed to support economic activity and employment. Finally, there is a third school, which considers that the (deficit and) public debt has little overall impact on the economy. This paper critically evaluates these competing paradigms considering the implications for economies in transition and developing nations. In particular, it is argued that the shift in budgetary norms from a year on year balancing to perpetual deficits is a relatively recent phenomenon especially, in the Anglo Saxon countries. This shift has been visibly accompanied by a substantial increase in the size of the public sector in these countries necessitating higher taxes and attendant distortion in incentives. Economies in transition would be wiser and healthier if they could avoid such mistakes by optimising the role of government, and facilitating markets and the voluntary sector. To this end, some general policy advice is also proffered.