Government debt is also known as public debt. It is the debt owed by a federal government to the internal or external sources. It is required when the stocks of government securities are insufficient to cover previous budget deficits. Budget deficits occur when the level of government expenditures exceeds its revenues. Based on macroeconomic theory, the level of government expenditure must be positive with the economic growth. The higher the expenditure, the higher will be the economic growth.
Government expenditure can be divided into productive and unproductive expenditure. Productive expenditure will be contributed to the economic growth in a few years’ time. Meanwhile, the unproductive expenditure will lead to the decline in the economic growth. Productive expenditure comprise of education and health. Besides, the unproductive expenditure consists of expenditure like pension and subsidies. Meanwhile, high budget deficit will reduce the level of economic growth.
In order to finance additional expenditures, the government will borrow money from internal sources. Since the demand of the loanable funds is also derived from the private sector, additional demand from the government will boost the interest rate. Consequently, high interest rate will distort the level of investment. Finally, the lower level of investment will lead to lower economic growth for the country. In addition, high public debt will also result to a financial crisis.
If a country is experiencing a trend of an increasing public debt, the investors may be worried about the capabilities of that country to pay its debt. Apart from that, they will ask for higher interest rate as a safety and profitable measures for them to keep financing the deficits. An increase in interest rate can distort the level of economic growth and would create financial crisis. Besides, it is also acts as an obstacle to the development because it will weakens the government’s ability to achieve macroeconomic stability.
It comprises the stability of inflation, interest rate and exchange rate target. It will also create adverse incentives associated with future taxes. High debt also will stop the social and developmental progress. Malaysian economy may not be able to achieve high and sustainable economic growth in the long-run if the federal government keeps borrowing money from the domestic sources in order to finance the budget deficit. However, there is no such evidence to conclude that the external debt can distort the economic growth in the long-run.