Deficit Spending and What It Means

Deficit spending is when a government’s expenditures are higher than the government’s income. National debt will increase while the country is running a deficit. Media portrayal and consensus of national debt and the national deficit is negative. Many politicians make a reduction in the national debt one of their platforms while also promising to increase benefits and lower taxes. The economics of that platform appear very hard to prove. While deficit spending has its drawbacks, it is unfortunate that the deficit is portrayed so bleakly. Deficit spending is not inherently bad because it is a fiscal tool that can mitigate the impacts of a recession if used properly. (Rittenberg & Tregarthen, 2009)

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When a government borrows money, it is increasing the national debt and engaging in deficit spending. This borrowed money is then injected back into the economy to stimulate aggregate demand. During the recession of 2008, the Obama Administration managed to get a $787 billion stimulus package passed. This money was sent back to consumers and firms with the hopes that it would stimulate the economy.

The government was using a principle of macroeconomics termed “the multiplier effect.” When the government increased its purchasing by increasing borrowing, it multiplied the fiscal effect. The expansionary government spending allowed firms to produce more goods and hire more workers, increasing income which then increased consumption. Recessions can be mitigated by expansionary and deficit spending.

There are some negative outcomes to deficit spending. The intense borrowing that the government does can “crowd out” consumers and firms. There is a finite amount of money that is available to be borrowed. Consumers borrow for schooling, cars, houses, and credit card purchases. Firms borrow for investment, such as new machinery and factories. When the government expands and must borrow money, the supply of loanable money goes down. This leads to an increase in interest rates. (Rittenberg & Tregarthen, 2009)

This increase in interest rates can crowd out consumers and firms, lowering aggregate demand. The increase in aggregate demand caused by government spending can be dampened by the decrease in aggregate demand caused by the crowding out effect. (Rittenberg & Tregarthen, 2009)

There are other challenges associated with deficit spending. One of the biggest challenges is the political process. United States national debt is represented as a large number, $22 trillion. The United States deficit is $1 trillion. These facts are heavily debated in politics. Many people seek to cut taxes on firms and consumers, but actions like that can increase the deficit if cuts to government programs are not made. A large portion of government spending is social security, Medicare, and military spending. These larger programs are very difficult to cut.

Another way the deficit can be reduced is by increasing taxes. However, this is a very politically unpopular move and the reality it is very hard to scale back the deficit when it means someone will lose their job or else be taxed more than before.

Some government programs, like welfare and unemployment, automatically adjust based on the economy. If the economy is strong, less people apply for those benefits. Likewise, if the economy is weak, more people apply for those benefits, which means the government is almost forced to borrow more money and run up the deficit. (Rittenberg & Tregarthen, 2009)

Another problem associated with deficit spending are the various delays in the process. There is a delay when recognizing problems like recessions. It took several months into 2008 to know that the USA had fallen into a recession, though the warning signs were there. There is also a delay for approving any budget changes, stimulus, or deficit increase. Politicians must devise a plan and agree on it before anything gets done. Then there is a delay for the impact. It can take a while for money to finally make it into or out of the hands of consumers and firms. (Rittenberg & Tregarthen, 2009)

Deficit spending is not a simple dilemma. In the short term, deficit spending can help economies recover from recessions by forcing an increase in aggregate demand. By using the multiplication effect, governments can ultimately get consumers to spend more and jump start the economy by using deficit spending. Unfortunately, deficit spending can crowd out consumers and firms who are competing from increased government borrowing. Deficit spending also tends to raise interest rates, which further hurt consumers and firms.

In the long term, deficit spending will hurt economies. Generally, while the economy is struggling, the government can borrow to increase aggregate demand. When the economy eventually recovers, the government should decrease its borrowing to lower the deficit spending. But the actual practice of scaling back government spending usually means cutting jobs and programs or else increasing the taxes on the rest of the country to make the deficit smaller. (Rittenberg & Tregarthen, 2009)

Deficit spending is a delicate matter, but when used properly, it can be very helpful to a nation’s economy.

References

Rittenberg, L., & Tregarthen, T. (2009) Principles of Macroeconomics. Irvington, NY: Flat World Knowledge.