Challenges for the EU New Member States
Edited by Massimo Florio
Chapter 1: Budget Deficits, Public Debt and the Level of Public Investment
Malcolm Sawyer INTRODUCTION There have long been two traditions in macroeconomic analysis with regard to budget deficits: constraints on them and need for them. The first tradition is labelled here ‘fiscal consolidation and Ricardian equivalence’ and the second ‘functional finance’. From the first tradition, the idea of an intertemporal budget constraint is taken as an expression of this approach, and that idea is briefly outlined and examined. From the second tradition, the idea of functional finance is outlined under which there is a presumption that the level of aggregate demand is not balanced with potential supply (usually but not always demand being less than supply), and the need for budget deficits arises to sustain a high level of demand. The chapter argues for the deficits/debt position to be approached in terms of functional finance, that is seeking to set the budget position to be compatible with the highest achievable and sustainable level of economic activity (which incorporates constraints arising from the level and structure of productive capacity, and balance of payments constraints). This would provide an alternative ‘rule’ for budget deficits to those such as ‘balanced budget over the cycle’. Government accounts should seek to follow the principles that the manner in which public expenditure (and notably public investment) is financed (for example through tax revenues, through borrowing, through public–private partnerships) does not influence the decisions on the level and structure of public investment. Further, any concern over the level of public debt should be tempered by the realisation...
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