Please see part 5 here: http://www.kataneh.com/index.php/2018/04/27/basics-of-macroeconomics-5/
These series of articles are for those intelligent group of people whose expertise are not economics or finance, but are still interested to understand the impact of macroeconomic monetary and fiscal policies such as interest rates, taxes or spending on the overall course of economy, their businesses, their employers, investments and of course their daily life.Therefore, in these articles, I have knowingly avoided using economic and finance terms and jargon, as much as possible.
The impact of different macroeconomics monetary and fiscal policies on each other, economy and growth are complicated and may cause vicious, benign or virtuous cycles. It is like a polynomial equation with many different interactive factors and coefficients. Changing the value of each factor and each coefficient will not only generate a different result, but may even change the value of some other factors in that same equation! And of course, changing one factor may generate multiple or totally different results for different values of another factor.
Knowing all those facts, in this article, discussion is kept very simple and to the point. At any time, we focus on one causal impact of one factor only if ALL other factors are assumed to remain constant.
Part 6- Government Income and Spending
a- Governments have two main sources of income; taxes and borrowing (bonds and treasury notes). Governments spend their income on public services, national security, and to run the government. They may also use their income to boost the economy through spending on infrastructures, such as roads, bridges and highways, or to ‘protect’ and insure certain sectors and industries.
Examples of protection are financial bailouts in the late 2000’s (in form of lending to financial institutions, of course), or protecting the agriculture sector if tariffs happen to limit demand for US agriculture products.
Examples of spending are government infrastructure spending to build roads, bridges, parks and highways. If government does not spend on infrastructures, or does not contract these projects to the right contractors, public safety and welfare will be compromised.
Military is usually the biggest item on the list of government spending. Through infrastructure and military spending, money cascades down to other sectors, creates demand for more jobs, which in turn boosts wages, consumer spending, business spending, and the economy.
Government also provides health insurance or old age security to the old people or (for some governments in the developed countries) to all. Relief packages are also provided if natural (or sometimes human) disasters happen.
b-Governments increase taxes or borrow more when they need higher income.
Now, imagine that your family has $200,000 of annual income, and only $5,000 of debt. Banks easily give you a loan of $1,000,000 at prime rate or a little bit higher. But if your family’s annual income is $100,000, with $20,000 of debt, banks may ask for two or more percent higher than prime rates on only $500,000 of loan. The higher your risk is, the higher the interest on your loan/mortgage will be, and the lower the value of the loan will be. That is because the terms of loan are less favorable for riskier borrowers.
Exactly similar to this scenario, as government’s income decreases, and their debt increases, people will ask for higher interest rate from the government on government’s newly raised debts. This will, of course, cause a vicious cycle, because the higher the interest rate is, the more the government should spend to pay for its interests on the debt, which means government’s spending will be higher. To stop or reverse the vicious cycle, the government should increase taxes or decrease (infrastructure, public or military) spending to increase their income, and pay out their debt.
Governments borrow by selling government bonds, treasury notes, and similar papers.
In short, governments borrow (through selling bonds and notes) or collect taxes to spend on public welfare and services, infrastructure, military, health care, relief efforts, and running the government. Higher spending and lower taxes are government’s fiscal policies to spur growth whenever needed.