Final answer:
External shocks can lead to increased government deficits and debt by necessitating additional spending without raising revenues. These shocks often result in temporary budget deficits as the government borrows to cover immediate needs, potentially leading to unsustainable debt and stifled economic growth.
Step-by-step explanation:
External shocks can significantly influence government deficits and debt levels. When a government experiences an unexpected negative event, such as a natural disaster or a geopolitical crisis, this can disrupt economic activity and require increased spending to manage the crisis. These shocks can lead to a temporary increase in budget deficits, as government spending ramps up to address immediate concerns, often without a corresponding increase in revenues.
An example of such a shock would be a significant rise in global oil prices, which can have a ripple effect on a country's economy, particularly if it's heavily reliant on imported energy. The increased costs can affect trade balances, and government spending may need to increase to support affected industries or to subsidize energy costs for consumers. This can lead to an uptick in government borrowing, as funds are required to cover the new expenditures.
In cases where a country is already carrying high levels of debt, external shocks can exacerbate the situation, leading to unsustainable debt levels, rising interest rates, and potentially reduced investor confidence. Additionally, if government borrowing to address the shock diverts funds from private investment, it could stifle economic growth in the longer term.