The Effects of Government Spending and Borrowing

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The Effects of Government Spending and Borrowing

Government borrowing can be inflationary because the government

borrows from banks, which increases the money supply. Banks assume

that consumers will not take more than 10% of their savings out and on

that basis are able to lend to the government. This increases the

money supply because the government has borrowed from the bank but the

consumer’s savings stay the same and therefore there is more money in

circulation. According to monetarist beliefs an increase in the money

supply will directly increase inflation. Inflation can lead to

unemployment, as people demand less due to higher prices and therefore

demand for labor maybe decreased. Inflation also creates uncertainty

for entrepreneurs, cost curves increase and revenue can decrease thus

squeezing profits. Also when inflation is in the mind of the

entrepreneur it can escalate easily as they will take inflationary

actions like automatically increase prices and therefore it is

imperative government spending/borrowing is controlled.

Although government borrowing does increase the money supply, the

monetarist view of a direct link between money supply and inflation is

wrong, as proved when Britain experienced recession under Margaret

Thatcher. In order to control the money supply the government cut

borrowing and spending, which in theory would reduce the money supply,

inflation and unemployment but interest rates had to rise to stop

consumer borrowing, which in turn increased the exchange rate. High

interest rates curbed consumer borrowing, which reduces demand for

products, along with a high exchange rate ruining demand for exports


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...ector borrowing is not

the enemy of unemployment.

If the government borrows too much then there will have to be

increases in taxes, mainly corporation tax and this will also

contribute to some unemployment, but the public sector does help

employment in some ways. Education and training (funded by the

government) provides a skilled, desirable workforce, which will

encourage British firms to employ British workers instead of looking

for other skilled workers in an increasingly globalized world. The

National Health Service also reduces the amount of residual unemployed

and therefore contributes to keeping employment levels high.

Government borrowing should only occur if for investment purposes and

if it will be repaid over the cycle, otherwise it destroys

entrepreneur confidence and eventually leads to unemployment.
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