Government Financing Requirements

The focus of this blog is on financial markets and financial institutions. The subject of public sector finance is fortunately well outside our scope other than to the extent that it impacts on these markets and institutions. In brief, however :
Income. Government income comes from taxes imposed on cor porates and individuals. The receipt of these taxes is highly seasonal. The absolute level of taxes expected is based on government economists’ forecasts for economic activity. The best economists are all born with two hands, thick skins and a good sense of humor. The actual level of tax receipts is often ver y different from that expected.
Expenditure. Cer tain par ts of government expenditure are fixed but larger par ts depend on the level of economic activity and unemployment. Little, if any, provision is made for major unexpected events, such as a war. The actual level of expenditure is usually ver y different from that expected.
Political pressures. Political pressures mean that forecasts for income have a bias towards being too high while forecasts for expenditure are biased towards being too low.
The difference between income and expenditure has to be financed through borrowing and this is usually achieved through the issue of bonds. The level of borrowing should also be affected by the economic cycle. Deficits tend to be largest during recessions and smallest (or even become surpluses) at the peak of the cycle. It is difficult, however, to differentiate between deficits that are due to cyclical factors and those that are structural in nature.
The overall result is that most governments are continually paying off debt from old bond issues while attracting new financing by issuing new bonds. These bonds are issued across a range of maturities var ying anywhere between three months and 30 years. The level of government borrowing has a direct effect on the demand for, and hence price of, money. Excessive levels of government borrowing make it harder and more expensive for the private sector to borrow and this is the phenomenon referred to as “crowding out” by economists. Just what constitutes excessive requires a political as much as an economic judgement.