30 June 2010

A Financial Crisis, Not A Deficit Crisis

What caused the deficits and rising public debt? The answer comes in two parts: present deficits and projected future deficits.

Overwhelmingly, the present deficits are caused by the financial crisis. The financial crisis – the fall in asset (especially housing) values, and withdrawal of bank lending to business and households – has meant a sharp decline in economic activity, and therefore a sharp decrease in tax revenues and an increase in automatic payments for unemployment insurance and the like.

According to a new International Monetary Fund staff analysis, fully half of the large increase in budget deficits in major economies around the world is due to collapsing tax revenues, and a further large share to low (often negative) growth in relation to interest payments on existing debt. Less than 10 percent is due to increased discretionary public expenditure, as in stimulus packages.

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