The discussion on austerity measures Assignment

The discussion on austerity measures - Assignment Example However, consistently high government deficit can be detrimental for the economy in the short run owing to the fact that the government will have to borrow in order to finance government deficit. (Nellis & Parker, 1996). There are two methods through which the government can actually finance its deficit i.e. it can either impose more taxes or have to borrow domestically or from the international organizations such as IMF and World Bank. Similarly having the higher government debt would ultimately put pressure on the government because most of the government revenue would go towards the servicing of the debt. Further, a higher quantum of government debt creates crowding out effect thus reducing the amount of credit available for the private sector. The lack of credit available to the private sector will therefore ultimately increase the interest rates in the economy and therefore invariably affecting the level of investment into the economy. The lack of investment therefore can furthe r result into the lack of capital formation and the economy may not be able to grow according to the estimates. The above laws therefore are critical owing to the fact that they outline the maximum limits to which economic variables such as government debt as well as the deficit can relate to the gross domestic product. Keeping both these economic variables therefore within a certain range will allow the governments to keep the detrimental affects of these economic variables under control. Data published recently indicate that the government deficit as a percentage of the GDP in EU area is 6.3% whereas the government debt is almost 80% of the GDP1. Countries with largest government deficits included Greece, Ireland, UK, Spain and almost all other major economies of the EU. Countries like Ireland and Greece received support from the EU whereas there is growing discussion about the Spain’s ability to repay its sovereign debt owing to higher government debt. Further, UK has init iated austerity measures in order to control the government expenditure so that the government debt can be rationalized. UK’s government deficit in almost 11.5% suggesting that the economy may not be in good shape and there is a greater need to implement economic strategies which can actually allow the country to remain within economic soundness. The higher ratios of the government debt as well as the government deficit therefore may suggest that the economies may require external support in order to keep themselves solvent. Thus the rules outlined clearly provide the best estimates for the countries to keep their debt and deficit within certain percentage to avoid such economic issues. 2) The circular flow of income suggests that there are three players in the economy i.e. the households, firms and the government. The national income which is generated in the economy therefore is generated with the interaction of these three economic entities. The exact relationship between these components therefore can be described in following equation: Y= AD= C + I + G The above relationship assumes that there is no external trade with other countries. However, if we introduce the trade with the external world, the above relationship will be : Y = AD= C+I+G+X X= Total exports – Total Imports The components of aggregate demand include the consumption, investment, government expenditure assuming that there is no foreign trade. The circular flow of income therefore suggests that the goods and services produced by the firms are consumed by