Budget Deficit and the Federal Government Debt in Malaysia

In general, most countries in the world, particularly developing countries, are facing significant budget constraints, in which the collection of tax and nontax revenues is less than the government's total expenditure. Therefore, borrowing either from the local capital or international capital markets is made. Borrowing increases government debts. The budget deficits and the growth of the government debt are the major factors that determine the health of macroeconomics. There is a solid consensus among economists mainly on the effect of budget deficits on macroeconomics in terms of crowding out private investment, increasing interest rates, expanding money supply and escalating consumer price and in certain extent affect exchange rate. Government bonds issued to finance budget deficits are also in question as part of the net wealth of private sectors. On the other side, there is an agreement that the budget deficits financed by the issuance of bonds will crowd out private investment through increasing interest rate. This paper plans to investigate the impact of budget deficits on Malaysia's economy. Cointegration test and vector error correction models are used to examine the impact of budget deficits on certain macroeconomic variables.