Page 558 - The Principle of Economics

572 PART NINE
THE REAL ECONOMY IN THE LONG RUN
Thus, the most basic lesson about budget deficits follows directly from their ef- fects on the supply and demand for loanable funds: When the government reduces national saving by running a budget deficit, the interest rate rises, and investment falls. Because investment is important for long-run economic growth, government bud- get deficits reduce the economy’s growth rate.
Government budget surpluses work just the opposite as budget deficits. When government collects more in tax revenue than it spends, its saves the difference by retiring some of the outstanding government debt. This budget surplus, or public saving, contributes to national saving. Thus, a budget surplus increases the supply of loanable funds, reduces the interest rate, and stimulates investment. Higher investment, in turn, means greater capital accumulation and more rapid economic growth.
CASE STUDY THE DEBATE OVER THE BUDGET SURPLUS
Our analysis shows why, other things being the same, budget surpluses are bet- ter for economic growth than budget deficits. Making economic policy, how- ever, is not as simple as this observation may make it sound. A good example occurred in the late 1990s, when the U.S. government found itself with a budget surplus, and much debate centered on what to do with it.
Many policymakers favored leaving the budget surplus alone, rather than dissipating it with a spending increase or tax cut. They based their conclusion on the analysis we have just seen: Using the surplus to retire some of the gov- ernment debt would stimulate private investment and economic growth.
Other policymakers took a different view. Some thought the surplus should be used to increase government spending on infrastructure and education be- cause, they argued, the return to these public investments is greater than the typical return to private investment. Some thought taxes should be cut, arguing that lower tax rates would distort decisionmaking less and lead to a more effi- cient allocation of resources; they also cautioned that without such a tax cut,
“Our debt-reduction plan is simple, but it will require a great deal of money.”