Answer to Question #63288 in Macroeconomics for Aisha

Question

The economy of Uganda has a budget deficit of USH 500B. This deficit is likely to be funded through domestic borrowing and taxation. Using an appropriate model, explain the macroeconomic implications of such a move.

Answer 1

Domestic borrowing and taxation for budget deficit funding are not the best government practices for national economy growth.
Increasing taxes causes lower economic growth that in longer term can cause higher cyclical deficit when government gets fewer taxes in future periods. Lowing of economic growth can be explained with spending cuts. Of course, for high economy growth period tax increase will not have effect spending much but it is not the case of Uganda.
What about domestic borrowing – it reduces the volume of available funds that can be invested in different businesses inside the country. So the result of domestic government borrowing leads to reducing overall capital stock in Uganda economy that also low economic growth.
To result, such government policies as taxation and domestic borrowing cause slowing of Uganda economic development.