Describe the three basic effects of budget deficit:

Ricardian Equivalence

Crowding-Out

Crowding-In

Ricardian Equivalence is an economic theory that argues economic stimulation will fail. According to this theory, when the government stimulates the budget deficit using debt, it will eventually fail because the customer spending will remain low. Thus, it argues that using government spending to cater for the deficit is not efficient.

Crowding-Out argues that budget deficit leads to a decline in the private sector spending. If the government is running a deficit budget, it is forced to borrow funds; this leads to an increase in the interest rates because the government will need funds to pay back the debt, which results in a slowdown in the private sector.

Crowding-In argues that budget deficit results in high private investment because the government takes debt to stimulate its spending; thus, the employment rate rises due to increased government spending. This leads to an increase in demand for goods and services, resulting in more private-sector investment.