In a boom, tax receipts rise and spending on benefits falls, naturally cooling the economy.
If investors lose confidence in a government’s ability to repay, capital flight occurs. This can trigger a currency crisis, as seen in the Eurozone debt crisis, where fiscal imbalances in one nation threatened the stability of the entire monetary union. 4. The Role of Automatic Stabilizers Fiscal Policy and Macroeconomic Imbalances
When a government spends heavily or cuts taxes during near-full employment, it risks "overheating" the economy. Excess demand pushes prices up, leading to high inflation. In a boom, tax receipts rise and spending
The most direct impact of fiscal policy is on . The most direct impact of fiscal policy is on
This inflow of foreign capital often appreciates the currency, making exports expensive and imports cheap, which leads to a Current Account Deficit . This phenomenon, where a budget deficit leads to a trade deficit, is known as the Twin Deficits Hypothesis . 3. Sovereign Debt and Financial Instability
When a government runs a large budget deficit, it often increases the national demand for credit. If domestic savings aren't enough to fund this, the country must "import" capital from abroad.
To fund its debt, the government competes with the private sector for loans, driving up interest rates. This makes it harder for businesses to invest, slowing long-term productivity.