Budget deficits are not uncommon to modern day economics. Budget deficits arise when the public expenditure exceeds the government receipts. There are times when these deficits arise due to deliberate government policies and there are times they arise unexpectedly due to the nature of business cycles. Some of these government policies is the lack of governments (in this case the American government), to control the rates of inflation, interest rates and general depreciation of the dollar.
Some of these incidents can be controlled using the three main tools of controlling the monetary policy by the Federal Reserve. These main tools are discussed below.
Open market operations involve activities like selling and buying of government bonds or treasury bonds. The sale of treasury bills to the banking sector or to the public is usually meant to reduce money supply in circulation while the purchase of the same from the public is meant to increase money supply. When the public purchases the treasury bonds, they actually pay up the money to the government. Once the money is paid up, the money supply in the economy reduces by the equivalent amount. By doing this, the Federal Reserve may have intended to raise the interest rates.
Once the supply declines money, the cost of getting money (interest) increases. Interest can be simply described as the cost of money. When the Federal Reserve increases the prevailing interest rates, this usually discourages borrowing. Once borrowing is reduced then the level of money supply within the economy is proportionally reduced by the level of the increase in interest rates.