Question

Over 85 percent of surveyed households in Indonesia have received at least one form of government social assistance from Indonesia's National Economic Recovery (PEN) Program, according to a nationwide survey in Indonesia, published in 2021.

In the pandemic year, the government's fiscal options are understandably quite limited. Revenues are down from a slowdown brought about by social restrictions, while expenditures are up, driven by extensive health and social assistance spending. This inevitably creates a widening budget deficit.

Based on Law No. 2 of 2020 concerning State Finance and Financial System Stability for COVID-19 Handling Efforts, the state budget (APBN) deficit has been allowed to exceed 3 percent of the national gross domestic product (GDP) for three years till 2022.


Question:
Using the loanable fund framework, explain the effect of this budget deficit on the economy (don't forget to indude diagram in your answer)
Over 85 percent of surveyed households in Indonesia have received at least one form of government social assistance from Indonesia's National Economic Recovery (PEN) Program, according to a nationwide survey in Indonesia, published in 2021.

In the pandemic year, the government's fiscal options are understandably quite limited. Revenues are down from a slowdown brought about by social restrictions, while expenditures are up, driven by extensive health and social assistance spending. This inevitably creates a widening budget deficit.

Based on Law No. 2 of 2020 concerning State Finance and Financial System Stability for COVID-19 Handling Efforts, the state budget (APBN) deficit has been allowed to exceed 3 percent of the national gross domestic product (GDP) for three years till 2022.

Answer 1

A budget deficit can have various effects on the economy, including crowding out private investment, contributing to inflation, and having long-term implications for government finances.

Step-by-step explanation:

The effect of a budget deficit on the economy can be explained using the loanable fund framework. In this framework, a budget deficit occurs when government spending exceeds government revenues. This means that the government needs to borrow money to cover its expenses, leading to an increase in the demand for loanable funds.

This increase in the demand for loanable funds can lead to several effects on the economy. Firstly, it can crowd out private investment. When the government borrows money, it absorbs a portion of the available funds in the financial market, reducing the amount of funds available for private businesses and individuals to borrow. This can lead to higher interest rates, making it more expensive for businesses to borrow and invest in new projects.

Secondly, a budget deficit can have an inflationary effect on the economy. When the government borrows money, it increases the money supply in the economy. If the amount of money in circulation grows faster than the real output of goods and services, it can lead to inflation. The increase in government spending associated with a budget deficit can also contribute to inflationary pressures.

Lastly, a budget deficit can have long-term implications for the economy. When a government consistently runs budget deficits, it increases the overall level of government debt. This can lead to higher interest payments on the debt, diverting resources away from productive investments and into servicing the debt. It can also lead to concerns about the government's ability to manage its finances, which can impact investor confidence and lead to higher borrowing costs.

In conclusion, a budget deficit can have several effects on the economy, including crowding out private investment, contributing to inflationary pressures, and having long-term implications for government finances. These effects can impact the overall health and stability of the economy.