Deficit spending refers to a state where a government spends more than it collects during a fiscal period. As such, the expenditure exceeds the revenue, thus implying a Keynesian economic approach to handling recessions. It creates an economic stimulus by controlling its spending power to trigger demand, hence stimulating the economy. The ideology is borrowed heavily from a British liberal economist, John Maynard Keynes, who argued that during a depression, an increase in government spending could balance a decrease in consumer spending (Rickman & Wang, 2020). Accordingly, avoiding long periods of high unemployment worsening the situation can be prevented by creating and maintaining aggregate demand.
Balancing the spending by consumers and the federal eventually restores the recession, and after the recovery, the state can pay off its debts. However, if the extra expenditure causes further inflation, the government can alternatively increase its tax collection to derive additional capital out of its economy. The difference between the federal budget and the available resources is referred to as deficit. It is calculated on a yearly basis and is drawn from treasury securities raising the national debt. The securities sold by the treasury generate interests which the federal state pays per annum. One salient feature in the operation of the Keynesian effect is the multiplier effect. The trait raises real domestic gross product triggering a rise in employment of labor (Rickman & Wang, 2020). A rise in government purchases generates a market for business output, encouraging consumer spending increasing the demand for business output. Other additional output triggers include private investment stimulation and infrastructural, education, and public health development, contributing to the strategy’s overall success.
Analysis of Deficit Spending
Deficit financing is highly beneficial to an economy experiencing recession if utilized appropriately. For instance, spending through cutting taxes or purchasing goods and services by the government can help reverse the economic fall. Moreover, as stability regains, the outlook for businesses is improved, resulting in a potential rise in investments. It is a strategic move that stands to benefit even future generations due to its long-term positive effect. It is highly remarkably applicable to catering for developmental expenditures and availing massive resources. It can help mobilize resources for fulfilling financial plans, which equally contribute to the advancement of government purchasing power (Eichengreen, 2020). Additionally, it has several multiplier effects on the economy, thereby encouraging the state to utilize underemployed and unemployed resources generating more income. The resulting mild inflammation triggers economic development, thus neutralizing the consequences of price increases if kept within reasonable levels.
Unsustainable deficit spending is detrimental to any economy and can worsen the depression instead of alleviating it. If it runs for a prolonged uncontrolled period, there is an enormous risk of high debt accumulation, which may hinder the federal from achieving its future obligations. When the deficit grows, repaying the balance may not be possible, leading to unsustainability (Eichengreen, 2020). It is ideally a self-defeating method since it usually leads to an inflationary rise in prices, and if not effectively managed, the benefits will not fructify. Furthermore, it promotes further disparities in socioeconomic classes in society. The affluent business people will flourish more, yet the fixed-income earners retain their financial positions without any significant growth. Additionally, deficit financing distorts investment patterns, further creating unpredictability. The arising uncertainty discourages investors from engaging in long-term projects; instead, they focus on quick profit yielding industries which are undesirable to a country’s development.
The crowding-out effect occurs when a government increases its spending but fails to increase the cumulative aggregate demand, causing a fall in the private sector’s spending and investment. When a state raises its expenditure, it can cater to it by increasing tax and borrowing. The former results in stress on the private sector in the form of higher income and corporate tax, reducing the discretionary consumer and firm’s income. Conversely, the latter state sells bonds to the private sector since this is its borrowing source, such as pension funds and investment trusts (Demirel et al., 2017). Consequently, the selling of Treasury securities hinders using the same funds to stimulate the private sector. However, it is imperative to note that crowding out does not always occur; it depends entirely on the state of the economy. Accordingly, the federal and private sector will be spending more if the economy is below full its full capacity.
Deficit spending can hinder a long-term economic growth because of its potential in creating more significant debts for the country. The higher national debts lead to higher interest payments which further strain the limited resources. It distorts the investment patterns, thereby limiting the investment attractiveness to investors. It also expands nonmarket actors who slow the growth rate of the economy. In most cases, the short-term positive effects are not efficiently and effectively managed, thereby prompting the negative curve if it extends for prolonged periods. The ideology was meant to be used to help countries recover from recessions to regain their stability. Nevertheless, its usage is rampant and repetitive; hence it leads to more tremendous financial drain than intended. Consequently, the state must balance its finances and expenditure to minimize the devastating effects of deficit financing.
Demirel, B., Erdem, C., & Eroğlu, İ. (2017). The crowding out effect from the European debt crisis perspective: Eurozone experience. International Journal of Sustainable Economy, 9(1), 1-18.
Eichengreen, B. (2020). Keynesian economics: can it return if it never died?. Review of Keynesian Economics, 8(1), 23-35.
Rickman, D., & Wang, H. (2020). US state and local fiscal policy and economic activity: Do we know more now?. Journal of Economic Surveys, 34(2), 424-465.