How does a government budget surplus affect the economy
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Harvard economist Gregory Mankiw noted in "Principles of Economics," a popular textbook in many undergraduate economics courses, that budget surpluses increase national savings, which consists of government savings and savings by households and firms. Mankiw noted that when the government collects more money than it spends, it retires outstanding debt. The surplus, by increasing the national savings, creates more money available for lending and reduces interest rates, stimulating investment.
Government faces various options for what to do with budget-surplus funds. One option, if the government has run budget deficits in the past, is to use surplus funds to retire the debt accumulated from those deficits, as Mankiw discusses in his book. In addition, the government could choose to refund the surplus funds to taxpayers, giving individuals and businesses additional money, which they could spend or invest as they choose. This perspective sees a budget surplus as a reflection of excessive taxation and thus, a need to refund the overpayment to taxpayers. A third option for the government would be to direct the surplus funds toward other spending, such as improved infrastructure, new domestic programs
or additional defense spending. The economic effects of additional government spending depend greatly on how policymakers allocate the funds.
Using funds from a budget surplus to retire all or part of the government's debt from previous budget deficits creates the potential for additional savings because paying down debt reduces the amount of interest the government pays on its debt. In the United States, for example, interest on the national debt is one of the largest categories of federal spending. Lower interest payments free up funds in the budget for other uses, such as infrastructure improvements, which support further economic development and expansion.
Fiscal policy in the United States has mostly been a series of budget deficits. The nation's last budget surpluses were in 1998 and 1969. Since the 1998 surplus, the nation has continued to run larger budget deficits.
Researchers at the Federal Reserve Bank of Atlanta noted that neither a government budget surplus nor a deficit represents a good summary of how government taxation and spending affect the economy. Rather, surpluses and deficits result from policy choices about government spending and taxes.Source: ehow.com