Cyclical Deficits: An Overview
Deficits occur when a government’s expenditures exceed its revenue for a given period of time. In a business cycle, an economy goes through various phases: expansion, peak, contraction, and trough (or recovery). When the economy is in a period of expansion, government revenue is typically higher and government expenditures tend to be lower. Conversely, during a period of contraction, government revenue tends to decrease while government expenditures typically increase. As a result, during periods of economic contraction there is a greater likelihood of running a budget deficit.
One type of budget deficit is known as a cyclical deficit. This type of deficit results from macroeconomic forces: those related to the economy-wide fluctuations in output and employment that are associated with the business cycle. A cyclical deficit generally occurs when government spending increases during an economic downturn in an attempt to counter the negative effects of the recession.
In the United States, the federal government typically runs a budget deficit during downturns as it attempts to cushion the economy from the effects of a recession. During economic expansions, the federal government typically runs a surplus, if it also reduces spending. Tax revenues tend to rise faster than spending during economic expansions, providing the boost that contributes to a budget surplus. The combined surplus reduces the amount of money the federal government has to borrow, which reduces the risk of a future budget deficit.
On the other hand, some countries have much less flexibility when it comes to countercyclical fiscal policy due to a lack of resources and/or political constraints. This is especially true in developing countries and fragile states that are experiencing relatively large economic fluctuations. In these cases, the federal government may not have the capacity to run large deficits during recessions and may be unable to take the necessary steps to counter the negative effects of a recession. Furthermore, many countries may face political constraints when attempting to implement economic policies in order to reduce the impact of cyclical deficits.
The cyclical nature of government deficits and surpluses has important implications for public policy. In order to ensure that public finances are sustainable and that the government is able to respond to the macroeconomic downturns, it is important for governments to have adequate resources that can be used during recessions when government revenues decline and spending needs to be increased. Furthermore, governments need to have the capacity to implement countercyclical fiscal measures in order to reduce the magnitude and duration of economic downturns. Finally, it is important that governments have the political capacity to enact and implement necessary measures that can help to cushion the negative effects of economic recessions.
