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Definition and Meaning:

The annual statement of expenditures and tax revenues of a government during a particular period is called federal budget. The federal budget, finances the activities of the government and is used to achieve higher level of national income and employment without inflation in the country.

When the expenditures of the government are higher than its revenue during a particular period of one year, the government has a deficit budget.

If the government expenditures are less than the tax revenues, the government has a budget surplus.

In case the government expenditures are equal to tax revenues, the government has a balanced budget.

When the federal budget is in deficit, the government has to borrow money, to finance the deficit between expenditures and receipts. The accumulated outstanding debt of the federal government is called the national debt.

We can describe national debt as the sum of all the past federal deficits.

In the words of Karl E. Case:

National debt is the total of all accumulated federal deficit minus surpluses overtime”.

National Debt and Determination of National Income:

The classical economists were of the view, if the economy is left on its own and there is no government interference in economic matters, it has a natural tendency to move towards equilibrium, of full employment without inflation.

The Keynesian economics reject the classic economics based on competitive market’s flexible prices. It emphasizes the possibility that an economy can be in equilibrium or less than full employment or above the level of full employment with inflation. The Keynesian economics stresses that fiscal policy (government intervention) can bring the economy at full employment equilibrium without inflation. The goal can be achieved by managing aggregate demand.

The increase in aggregate demand can be brought about by adopting expansionary fiscal policies and decrease in aggregate in demand by contractionary fiscal policies tax cuts and government spending increases the aggregate demand for goods and services (expansionary fiscal policies) and tax increases and reduction in government spending decrease the aggregate demand (contractionary fiscal policies).

When the government increases its spending to stimulate the economy, its budget deficit increases. If the budget deficits continue to increase overtime, the national debt burden increases. The increase in government expenditure through budget deficit is undertaken to curb recession. The government here has a choice. It can increase revenue by raising taxes. This method is not effective, because the rise in taxes reduces the disposable income of the people and hence fall in demand for goods. The government, therefore, has no other alternative but to resort to budget deficits if expansionary effect in the economy is to be realized.

In recession, the government spends the borrowed amount from internal or external resources by undertaking public works program on a large scale. The undertaking of the public works programs raises the personal incomes of the households and business firms which lead to higher consumption of goods and services depending on marginal propensity to consume of the people. The increase in demand for goods brings about expansion in output which further generates employment and income via multiplier. The rise in income and as a consequence in investment raises the aggregate demand for goods and shifts the aggregate demand curve upward closing the recessionary gap till the equilibrium is established at the full employment level.


The effects of increase in government expenditure through budget deficits for curing recession is now explained with the help of diagram.

In the Fig. 26.1, it is shown that the aggregate demand curve C + I + G intersects the 45° line at point E1. the equilibrium level of income is OY, which we assume is below the full employment income OYF. There exists a capacity in the economy for expansion. The economy is faced with deflationary gap equal to E2B. If the government increases its expenditure by E1H, the aggregate demand curve will shift upward to full employment level of OYF. The injection required to the amount of E1H will lead to multiple rise in income from OY1 to OY2. The equilibrium national income is restored to full employment level.