A decrease in government spending might increase the deficit if it leads to a decline in economic output.
This is because a decrease in government expenditures will lead to lower levels of aggregate demand.
Which will then cause GDP and national income to fall.
In this post we’ll explore how changes in government spending can have an impact on the fiscal balance and vice versa.
In an economy with a fixed output level.
If government expenditures decrease this will lead to lower levels of aggregate demand and GDP.
The fiscal deficit is equal to the difference between total tax revenue .
Spending on goods and services by all sectors in the economy, including households.
If there are fewer transactions then it means that taxes collected from economic activity will be smaller.
Than when higher levels of expenditure occur.
This can lead to either the first option would have a worse impact on debt/GDP ratio (as less money is raised via taxation).
In turn, this could mean that interest rates rise as investors believe there’ll be more future defaults due to increased risk-taking Given these possible effects.