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A deficit or debt crisis occurs when a country's public debt exceeds its income in terms of taxes or GDP. This suggests that the government is unable to fulfill its debt obligations and is most likely experiencing poor economic development. The debt incurred by the government is important to the degree that it cripples the nation's economies. This pattern has been exacerbated by recent news about the Greek debt crisis and the American debt crisis (Samuelson).
A sovereign debt crisis occurs when a country's economic activity boom lulls it into a false sense of confidence. This is characteristic of economic bubbles. During the bubble, a lot of taxes are collected and the country can afford to prepare a bigger budget. However, when the bubble bursts, the country is suddenly faced by a severely reduced revenue base which can no longer keep up with the budgetary demands, both current and previous. At this point, the debt can reach 100% of the Gross Domestic product. This is an indication that the country may not be able to sufficiently exploit its tax base to cater for the debt (Economist.com).
Additionally, the debt crisis can be caused when a government reduces its tax revenues. This can happen when an administration deliberately eases the tax burden on individuals. An example of this case is the United States debt crisis. The Bush tax cuts and the 2008 financial crisis contributed to the lowering of tax revenues that saw the United States incur a debt that exceeded its Gross Domestic Product. As a matter of fact, these tax cuts had been designed to get the country out of recession. The rationale was that the tax cuts would encourage consumers o spend. The increase in demand due to the increased expenditure would then stimulate the economic growth that was deemed necessary to spring the country out of recession. The resultant scenario as a debt crisis that started in mid-2000’s and spanned for over a decade (Li).
This triggers a series of events. Investors start pulling out, banks start going under, the economy deteriorates and the industries start failing. Once investors sense that the country is no longer economically vibrant, they tend to pull out. Potential investors shy away and current investors reduce their activities in the country. These activities are taken by the investors in order to safeguard their investments.
Banks start going under in an economic crisis. People often start withdrawing money from financial institutions. This is due to the fact that they do not earn a surplus to deposit, as a matter of fact, they are short of cash. From this point of view, they are prompted to retrieve the money they had stored in the bank. The banks experience massive withdrawals leading several of them to bankruptcy. This adds a burden on the government since it has to help rescue such institutions that are vital o the economy. After the financial institutions are in trouble, it is only a matter of time before the economy deteriorates further and industries start failing. Consumers get to a point where they have little, disposable income and as such cannot afford the products that their own industries produce.
The debt crisis is a complex phenomenon that must be handled carefully. There is no foolproof way to avert it; at least none has been documented. Once it starts, it usually has to take its course, as any natural phenomenon does. Attempts to correct it can reduce it or exacerbate it. Importantly, what works for one nation may not work for another. Each scenario is often unique in its complexity.
Economist.com. The never-ending story. 14 November 2015. 26 January 2017
Li, Hao. What is a Sovereign Debt Crisis? Why is it so Scary? 19 November 2011. 26 January
Samuelson, Robert J. Financial crisis 2.0? 16 October 2016. 26 January 2017
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