The government borrowings will increase as it will have to meet the deficit that has been created. This will be done by selling the government bonds. The increased debt of the government will result in increase in interest payments. This will have huge opportunity cost. For example the amount spent by the government in interest payments could be used for welfare or benefit of the society. These aspects will suffer as a result of this which further put pressure on the public as to meet the interest payments, the taxes will increase and the burden on the public will increase.
The selling of bonds by the government will also impact the interest rate and inflation in the economy. As government will sell bonds the interest rates will increase. This is because the investors will have to be attracted to buy more debt. With the increase in the government interest rates the interest rate in the markets will also increase. However, if the debt of the government is high, it will also become difficult for the government to raise debt. This is quite risky situation. The other way that can be employed by the government to pay debt is by increasing the money supply raising the inflation rate in the market.
Thus the budget deficit will have huge economic effect which will have to be controlled to maintain stability in the economy. IT has been argued that small budget deficit may not be an issue as the government debt is least risky. However, if the budget deficit can be controlled it would be quite beneficial and will have a positive impact on the economic welfare. Conversely it may be better to reduce budget deficit as it will keep the things in control. Thus the target should be to reduce the budget deficit.
The total demand in an economy is given by the aggregate demand. The aggregate demand is a function of Consumer Spending, Investment, Government Spending and net exports. Thus with the fall in government spending the aggregate demand will come down. This kind of policy is adopted to bring down the inflation level in the economy.