As the baby boom generation begins to reach retirement age and the increase in t

Question

As the baby boom generation begins to reach retirement age and the increase in the life expectancy in the US, people will be receiving Social Security payments for a longer period of time. Thus, the government expenditures will increase with the larger and longer-lived elderly population, but tax revenues (that finance the Social Security program) will not increase since the working-age population has not changed. As a result, government deficits are predicted to become larger in coming years.

In your opinion, what should the government do to handle this situation?

Explanation / Answer

Fiscal deficit refers to the excess of total expenditure over total receipts (excluding borrowings) during the given fiscal year.

Fiscal Deficit = Total Expenditure – Total Receipts excluding borrowings. The extent of fiscal deficit is an indication of how far the government is spending beyond its means.

Fiscal deficit indicates the total borrowing requirements of the government. Borrowings not only involve repayment of principal amount, but also require payment of interest.

Interest payments increase the revenue expenditure, which leads to revenue deficit. It creates a vicious circle of fiscal deficit and revenue deficit, wherein government takes more loans to repay the earlier loans. As a result, country is caught in a debt trap.

Government mainly borrows from the Fed to meet its fiscal deficit. Fed prints new currency to meet the deficit requirements. It increases the money supply in the economy and creates inflationary pressure. Government also borrows from rest of the world, which raises its dependence on other countries. Borrowings increase the financial burden for future generations. It adversely affects the future growth and development prospects of the country.

Government may borrow from Fed against its securities to meet the fiscal deficit. Fed issues new currency for this purpose. This process is known as deficit financing. Borrowings are considered a better source as they do not increase the money supply which is regarded as the main cause of inflation. On the other hand, deficit financing may lead to inflationary trends in the economy due to more money supply.

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