Decision Memorandum on Budget Deficit

Introduction

Judging by the recent economic woes, it is apparent that the national debt continues to rise whereas the leaders are struggling with the passing of the budget. The United States national debt has hit its highest point ever since post World War II and the rise continue to become unprecedented as well as unsustainable. Moreover, the high and ever-rising debt levels threaten economic growth and the associated standards of living of all Americans since investment itself continues to dwindle, and the country is becoming less competitive as compared to others such as China. The most important step in making the economy healthy is to stabilize the debt at a reasonable level, and as such, the short-term goal of the economy is to stabilize the debt at 70% in 10 years. However, the long-term goal of the economy is to lower the debt further down to 40% by 2050, and this is expected to give the economy a space to deal with the impending emergencies.

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The budget deficit is a phenomenon that occurs when the spending by the government is larger than the revenue from taxes. Changing the economic course will entail the rising debt rate, which must be halted as a share of the economy especially in the medium term. Furthermore, the debt levels must be reduced to historical levels in the long-term. The deficit for the U.S Federal Budget for 2019 is estimated to be $985 billion. The data covers the period spanning from 1st October 2018 to 30th September 2019. The reason for the occurrence of the deficit is that the U.S government is planning to spend $4.407 trillion is much higher than the available revenue which is estimated to be $3.422 trillion. The deficit is about 18% higher than that achieved in the past year. Also, the fiscal year 2018 had a deficit in the budget amounting to $833 billion. In 2018, the spending was $4.173 whereas the revenue was $3.340 revenue.

The main reason behind the current budget deficit is believed to be entitlement programs. However, experts have argued that that is just part of the story since the current budget deficit has practically emanated from three main factors. The first and the most obvious cause of the current budget deficit is the 9/11 attack which prompted the government to declare war on terror. The war has seen the country spend double on military compared to what it used to spend before. For instance, in 2013, the spending on the military was $437.4 billion, and this rose rapidly to peak ate $855.1 billion in 2011. Also, this includes off-budget spending on emergencies as well as the usual budget of the department of defense. Moreover, the budget is also inclusive of other departments that support defense including the veteran affairs department budget, National Nuclear Security Administration and Homeland Security.

Noteworthy, the administration of President Donald Trump has set a record in defense expenditure which is set to hit $874.4 billion in 2018 and $886 billion in the fiscal year 2019. For instance, the Trump administration is already calling for more funds to fight the militia group ISIS whereas Congress gave a green card to a two-year reprieve from seizure for spending on the military. The spending of the U.S government on military activities is believed to be larger than those of the coming ten governments put together, and it is also ten times larger than the expenditure of Russia on military while it is four times greater than that of China. It will be very difficult to attempt to reduce the budget deficit of the United States without cutting the spending on military activities.

Secondly, the government seems to have increased its mandatory spending. As such, it means that benefits payouts on services such as Social Security, Medicare and other mandatory services have increased. Since 2011, this amount has exceeded $2 trillion meaning that the costs consume two-thirds of the revenue of the United States annually. More importantly, the payments of these benefits can only be altered through an act of Congress which amends laws about the programs. Also, such an amendment will need to be voted for by the majority of members of the two houses, and this phenomenon has very little chances of occurring anytime soon. The reason behind this is that any law that supports the deduction of benefits deprives the beneficiaries of their money. Since the country has a powerful demographic of older people, this would mean that the lawmakers would be voted out of office.

Finally, the tax cut proposed by President Trump would lead to fewer revenues since it aims at reducing corporate rates, personal income rates, and taxes on small businesses. The move is further expected to lead to a total amount of $1.5 trillion in the coming ten years. However, according to the Joint Committee on Taxation, the strategy is most likely to create a 0.7 per cent annual growth. The enhanced growth will create revenue which can be used to offset some of the tax cuts, and as a consequent, the budget deficit will increase further to $1 trillion in the next ten years.

Moreover, it has been established that the government of President Donald Trump overspends as compared to the expenditure by the public. The perception of the political class is that when the government spends more, then it stimulates the economy. The reason behind this is that government expenditure is also computed as part of the gross domestic product of the economy. As a consequence, voters tend to reward them for thinking that they have created jobs and have contributed to the growth of the economy. On the other hand, politicians risk losing elections when they raise taxes and the unemployment rate is high. However, investors are the first group of people to punish the government when the deficit is raised. The buyers of sovereign debts at certain points get worried that they might not get their investment back. Therefore, the investors demand higher interest rates to take care of the impending risk. As a consequence, growth will slow down, and this will leave room for the government to keep a reasonable debt level.

Nevertheless, the United States at the moment does not suffer from the problem mentioned above since other countries such as China are ready and willing to buy treasury bonds from them. As a result, due to exports, they get hundreds of millions of dollars in exchange. Since they are obligated to invest the hundreds of millions of dollars somewhere else, the United States treasury notes are safe. Consequently, the interest rates of the United States are kept constantly low by the demand by other countries such as China for treasury notes. Thus, the Congress is not bothered to come up with interest on the debt payments as punitive measures.

The citizens, however, should understand that a budget deficit issue is not an immediate problem. When it is moderated, it creates enhanced economic growth, and it provides income for families and businesses. As a consequence, the spending by these businesses and families leads to a stronger economy which will make other countries not to shy away from lending to the United States because after all, the government has always paid back the debt. The main concern to the citizens will, however, occur when the debt-to-GDP ratio gets close to or exceeds 100% which is the point at which the lenders begin to get concerned. The worry at this point as it occurred between 2011 and 2013 was that the United States would not honor its pledge to pay back the debt when the Republican and Tea Party congressmen threatened to default the debt. Although the government reduced the deficit in the 2017 budget, it did not have any intentions of eliminating it.

Furthermore, the Office of Management and Budget predicts that by the fiscal year 2027, the United States budget will have become surplus. Also, it is widely accepted that to reduce the current budget deficit; the US must undergo the hotly contested and painful process of cutting spending or increasing taxes. By 2017 when the budget becomes surplus as forecast by the Office of Management and Budget would be the first time the budget will be in tandem with the predicted revenue since President Clinton's administration a decade ago when the government ran a budget without the deficit, and the rate of unemployment was low at 4%. During this time, the government had very little to do with the taxes and cuts.

The biggest surprise that most people are unaware of is that if taxes are raised while spending remains high, the budget deficit gets even larger. However, despite the obvious logic behind this theory, the administration of President Donald Trump seems to think that things might work differently for them. Alternatively, the administration can aim at making everyone happy by cutting the taxes as well as spending. As a consequence, the tax cut would create economic growth and revenue that can cater for both personal spending as well as government spending. However, the Office of Management and Budget (OMB) at the White House admits blatantly that this is yet to become a reality. Nevertheless, Trump's tax cuts managed some achievements concerning certain important things; for instance, it managed to make the businesses of the United States more competitive in the global market.

Proposed Solution to the Problem

I propose that a quick action should be taken to deal with the situation judging by the potential magnitude of economic effects. As a result, I propose in this memorandum that the only viable solution to the problem of budget deficit in the United States is to raise the exchange rates. Through this process, the economy will have less severe effects especially with regards to macroeconomic stability and inflation as compared to tax cuts or reducing government spending. Furthermore, I am fully aware that monetary policymakers have this knowledge and therefore an action will be taken as soon as possible. The Treasury and the Fed should look at policies that aim at lowering the value of the dollar. When the value of the dollar is lowered, it gives incentives for exports and hence economic growth. Noteworthy, it is now widely accepted that the real exchange rates are the most important relative price in an economy. Alterations of the real exchange rates affect the flow and balance of payment.

The real foreign exchange rate is an endogenous variable that reacts to both policy-induced and exogenous shocks. However, nominal exchange rates are usually regarded as a policymaking tool. Nevertheless, both the two rates have been determined to be related to each other. For instance, for effective policies, it is pivotal to gain an understanding of the factors that influence the real exchange rate. More importantly, policymakers ought to understand how real exchange rates respond to the changes occurring in the exogenous variables. Moreover, there is a general agreement that the impacts of different exogenous factors affect real exchange rates through four channels including interest rates, income, absolute price and relative price. Furthermore, the relative importance of each one of these factors has been found to vary between countries. Generally, however, it largely depends on how open an economy is as well as the relative effectiveness of the monetary and fiscal sectors in a country. The unprecedented growth in government budget deficit in the recent years has been of great concern for many economists.

Deficits are known to create inflation if the monetary policies allow it to do so especially if the Federal Reserve reacts to the situation by increasing the growth of money. One of the ways in which President Trump's administration has created an atmosphere of the abundance of money in the economy is by cutting the taxes although this is cou...