1) Do you think that the financial crisis that started in 2008 and the

recession that followed justified the massive increase in the size of the
federal budget deficit? Why or why not? In your answer, state the size
of the current budget deficit, the effects of large budget deficits on the
economy, and the arguments for and against a balanced budget
amendment.
US faced and saw one of the worst financial crises in 2008 when the
economy was in deep recission.2008 financial crisis collapsed US
economy, total demand, investments as many investors and
individuals lost their wealth as financial market dropped too minimum.
As monetary policy utilized its primary tool, which is expansionary
policy, Federal Reserve had to lower the federal funds to almost zero to
avoid even further economic depression. To evaluate and justify budget
deficit caused after 2008 financial crisis, we need to evaluate the
impact and severity of collapse, long-term spending and fiscal policy. It
is important to make a note that current US budget deficit is sitting at
$1.8 trillion as of 2025. And its national debt is at $37.64 trillion
according to Congressional Budget Office (CBO, 2025). These numbers
showcase years of spending in deficit and never-ending debt.
Continuous deficits always have negative impact on current and future
economy. They consume most of domestic savings towards actual
principal repayment and moreover, most of the budget needs to be
spent towards interest payment to maintain these huge deficits. This
crowds out private investment and causes slower economic growth.
The budget deficit that was cause due to 2008 financial crisis
was on a wide range justified by the macroeconomic theory specifically
Keynesian. It is considered that 2008 financial crisis caused lower
aggregate demand, increased unemployment and financial markets
halted. Blanchard and Johnson (2013) argue that “in severe recessions,
fiscal stimulus is essential when monetary policy becomes constrained
by the zero lower bound” (p. 498). Approximately $800 billion was
manually injected into the economy by the American Recovery and
Reinvestment Act (ARRA) in 2009. Short term benefits of budget
deficits are increases aggregate demand, decreases unemployment
and financial stability. But it also comes with long term risks like,
crowding out domestic investments, higher costs to maintain debt,
decreases financial flexibility and possibility of inflation.
Arguments for Balanced Budget Amendment: Supports state that this
would force and encourage policymakers to focus on spending rather
than deficit, if borrowing is limited, debt-to-GDP can be maintained
 over time, lower borrowing also reduces interest rates which will
increase investments.
Arguments against Balanced Budget Amendment: Economists worry
that it might remove countercyclical policies that are required during
recessions. Forces policy makers to cut social welfare spending, if
forecasts are not met, might face mid cuts.
2) Do you believe that the fiscal stimulus package which was
implemented to address the Great Recession and which resulted in a
large increase in the federal budget deficit will eventually do more
harm than good? Why or why not? In your answer note the current size
of the budget deficit and national debt and discuss the potential effects
of debt financing on the trade deficit, money supply, and future living
standards.
The fiscal stimulus implemented during great recission what a much-
needed policy for short-run benefit. But the result in financial shift it
caused poses long-term risks like permanent higher debts that could
impact economy in a negative way if its not addressed. Specially the
financial stimulus by the Americal Recovery and Reinvestment Act
(ARRA) in 2009 is till date conceded as the most debated policy in US
economic history. In order to understand if fiscal stimulus does more
harm than good requires us to study short-term benefits, long-term
risks and overall macroeconomic effects. Until 2025, US has a national
debt of $37.64 trillion according to Congressional Budget Office (CBO,
2025) and a budget deficit of $1.8 trillion as of 2025. Thes high
numbers contribute to frame a picture of long-term impacts and
consequences of crisis-driven deficit spending.
Short-Run Benefits: Fiscal stimulus was always considered a much-
needed step for short-term benefit during the great depression. In
2008, when US economy was seeing one of the worst financial crises,
along with increasing unemployment, lower aggregate demand and
shrinking GDP, it was seen as a necessary step to be taken. The IMF
(2012) stated that government spending had huge positive impact
during the Great Depression as fiscal multiplier were high. This induced
stimulus helped the financial market to improve, reduce
unemployment and improve investments and confidence.
Long-term Concerns: As every coin has two sides, fiscal stimulus also
has long-run complex issues. It raises questions and concerns about
national debt, sustainability, interest rates and equity.
a. Trade Deficit: As the government borrows aggressively, foreign
investments increase that causes US Doller to appreciate. Due to
 appreciation of domestic currency, imports become cheaper and
exports become expensive causing trade deficits. Debt-financed
stimulus can make trade deficit worse.
b. Money Supply: Fiscal stimulus did not directly impact money supply.
But if US bonds are not purchased at sustainable interest rates,
Federal reserve has to buy the debt which pushes to print more
money. This risks inflation.
c. Living Standards: It directly impacts future living standards as
interest rates are high which reduces loans, crowding out might
slow down economic growth, lower wages cause lower national
savings.
3) “The recent sharp increase in the U.S. national debt reduced national
saving and this was the primary reason for the low level of investment
spending during the last recession.” Comment on this statement. In
your answer, explain what factors may affect investment spending.
The claim from the statement that the sharp rise of US national debt
caused a reduction in national saving and is the primary cause of low
investment spending during Great depression is not entirely true and
does not interpret correctly. It is acceptable that when national debts
rise, national saving reduce and private investments crowd out,
statement does not completely justify when its applied to recessionary
conditions. Investments in generally depend on a lot of factors like
business expectations, market conditions, credit conditions, interest
rates, and overall demand. Even investments done during recession
look for these factors and national debt and national savings are not
the dominant factor.
Why national debt and national savings were not the main reason for
low investments:
a. When national savings reduce due to national debt, we expect
interest rates to rise significantly. But in contrast, interest rates
were low during recession. The link between debt to low
investments did not work here.
b. Expectations are the foundation of investments, it can be about
market value, profits and other areas. Due to uncertainty during
recession, investors had no expectations that caused low
investments.
c. Many banks faced tight credit conditions due to mortgage assets
and hoarded reserves. This did not allow investors to secure loans
even if they wanted to invest.
 d. Many firms were operating below capacity during recession. They
had many machinery and production units sitting ideal and they did
not have the need to invest in capacity. Lowest utilization was
recorded during recession.
Other factors that affect investments are:
a. Interest Rates: When interest rates are low, they attract
investments. But during recession, even if interest rates are low, if
market expectations are low, investments cannot be attracted.
b. Confidence: Uncertainty during recession causes low confidence
among investors.
c. Profits: If companies do not meet revenue expectations and profits,
internal budget allocation for investments will reduce.
d. Technology: Innovation in general requires large investments, during
recession even innovation adaption decreases.
e. Aggregate Demand: During recession, the aggregate demand
reduces which reduces returns as well.
4) If the government managed to reduce the budget deficit and
eventually achieved a budget surplus, what would be the effects on
interest rates, national saving, and future living standards?

If the government manages to reduce federal budget deficit and

specially manages to be in budget surplus, it has significant impacts in
various areas like interest rates, national savings, living standards and
investments. This will have a positive impact on long-term
macroeconomic outcomes. A budget surplus means that the
government is getting more revenue compared to its spending. Instead
of being the borrower from markets, it has its own savings. Short-term
effects may depend and vary based on situations and conditions, but it
will have significant impact in long-term by improving national savings,
improving living standards and lower interest rates.
a. Interest Rates: Usually when, governments are in deficit, they
borrow more money to fund the spending. When these deficits
shrink and possibly vanish, government borrowing reduces
significantly and instead puts the funds in financial system.
According to Mankiw (2021), “a reduction in government borrowing
lowers the equilibrium interest rate by reducing the demand for
loanable funds” (p. 412). When interest rates are low, it reduces
borrowing costs that encourage private investments, industries tend
to expand rapidly. When we look at history, in 1990’s when
 government was in budget surplus, long-term treasury yields
declined and private investments increased.
b. Effects on National Savings: National savings is a combination of
private savings and public savings. When governments are in
budget deficit, public savings are low which makes nation savings
low. When budget deficit is reduced, public savings increases which
raises national savings as well. Mishkin (2019) states that “An
increase in national savings shifts the supply of funds rightward,
lowering interest rates and increasing investment” (p. 325). When
national savings are increased, it directly increases capital. It also
decreases dependency on foreign borrowing or investments and
improves long-term economic growth in future. Higher national
saving also improves current account deficit. If government borrows
less from foreign countries, US’s national investment increases over
time.
c. One of the most important areas where reduced budget deficit has
is living standards. When a country has higher national savings and
lower interest rates, it attracts more investments. This increases
wages, productivity and long-run economic growth.

5) Assume the government finances a spending increase by issuing new

securities. Does this create a burden on future generations? Why or
why not? Would it make a difference whether the spending increase
was used to finance the building of a new highway or to send troops
abroad to fight a war in another country?

When spending increases for any reason by the government, they

usually finance it through additional borrowing i.e., by issuing
additional new securities. This additional borrowing has an impact on
long-term economic growth and financial sustainability. To decide if the
borrowing will be a burden of future generation or not can be done only
by understanding the usage of the money. It depends on if the
spending was done on public productive issues or on non-productive
issues. In majority of the cases, future generations pay the price for
higher borrowing or deficits as they will pay more taxes to maintain
these loans as interests or to pay the principle.
When government borrows more money and issues new securities, it
directly impacts national debt and savings. According to Mankiw
(2021), “government debt represents a claim on future taxpayers” (p.
412). Future generation pay the price due to:
 a. More borrowing means more deficit which causes fewer national
savings. Low national savings reduce loanable funds, raise interest
rates and less sustainability. If there are low investments today,
there will be low opportunities and productivity in future.
b. As the debt grows over time, interest payments to maintain these
debts also increase. Every year, majority chunk of budge is spent on
interest payments. Future generations must pay higher taxes to
maintain these debts.
c. When foreign investors buy more domestic securities, future
interest payments flow abroad. Blanchard and Johnson (2013) state
that “foreign-held debt implies a transfer of resources from
domestic residents to foreign creditors” (p. 512).

It also depends on how the borrowed money is spent. It makes a

difference if the spending is an investment or consumption.

a. Building a highway: If the government spends money on

infrastructure like building a highway, bridges or research, it will be
a burden as debt but also has results in future. Its an investment for
future generations and can be considered as an asset. A new
highway improves connectivity, reduces transportation costs,
collects tolls to cover building costs and helps to improve GDP.
b. Fighting a war: If the government spends borrowed money on
fighting a war abroad, all the resources like ammunitions, solders,
fuel, equipment spent are consumed and destroyed. There is no
positive result waiting from this kind of spending for future
generations.

References:

Blanchard, O., & Johnson, D, R. (2013). Macroeconomics (6th ed.). Pearson.

International Monetary Fund. (2012). World Economic Outlook: Coping with

high Debt and Sluggish Growth.

Mishkin, F. S. (2019). The Economics of Money, Banking, and Financial

Markets (12th ed.). Pearson.