Deficit Spending
March 23, 2009
Overview
Deficit spending can also be termed as ‘budget deficit’ or simply ‘deficit’. It is the amount by which a government’ spending exceeds its collected revenue over a given period of time. It is not limited to the government but economically, even when an individual or a company’s income exceeds the income, it is referred to as deficit spending.
Non-deliberate deficits
It is important to know that whereas some deficits can be intentional, not all are. For instance, a government deficit can be as a result of some policy decisions reached over time. This is to say that, an economy can go into a recession due to a monetary policy, resulting in the rise of government deficit spending. Still on point, with less active economic trends, a moderately progressive taxation system would mean that the tax revenues fall automatically. This may also mean that transferring payments for social security insurance payments such as unemployment benefits may escalate.
Government deficit Spending
To understand the government deficit, it is wise to first understand how deficit spending applies in such a scenario. Basically, when a government’s expenditure (which includes, and not limited to transferring grants and purchasing goods and services) exceed the revenue it generates mostly through taxation, the government budget experiences a deficit known as the deficit spending.
Rationally, the government would be forced to borrow capital from wherever to continue with its daily running, therefore increasing the debt further. The more the debt increases, the more the interest and interest rates also increases. This is because, during the borrowing process, the government accepts bids, measured in terms of interest rates. Thus, the interest rate bid forms the basis of the prevailing interest rate.
The more the government borrows, the more it sinks in to debt services and there will reach a time it will no longer afford to borrow. This is when such a state is referred to as crowding out. In a nutshell, crowding out means deficit spending has created a huge economic dent, therefore sending the economy into a deep descending spiral.
It is a contented issue amongst economists as to whether a government deficit is good or bad as it cannot be determined vaguely; the specifics have to be examined. Basically, whatever type of borrowing can be good or bad. Practically, when a government borrows to combat severe recession or a depression or borrows to invest in the public such as education, majority of stakeholders agree that the deficit is necessary and beneficial.
Conversely, if the deficit is used to finance extravagant expenditure or the current economic consumption of the government, a vast majority of economists would advise on tax cuts to rouse private investments, transfer deductions or/and deductions in government purchases, in an effort to have a balanced budget.
Effects of deficit spending
Deficit spending is recommended to put an end to, or to moderate recession. Deficit spending causes a multiplier effect in an economy. This means that in an economy where there is high unemployment, when the government increases its purchases, it creates an opportunity for business production, consequently generating income and stimulating increases in end user spending, further increasing the demand for business output.
Deficit spending equally has an accelerator effect on an economy. This is brought about by the stimulation of raising business profitability and encouraging optimism which spurs private fixed investments. This will ultimately increase the capabilities of the society to have a sustainable supply production in the long run.
Economies argue that deficit spending may create inflation, or spur an existing passive inflation. Conversely, the positive effects of deficit spending outweigh the negative ones, with the potential of sustainable supply output in the long run being the key long term effect.
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