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Deficit Spending and Economic Growth

Table of Contents

Introduction: Defining Deficit Spending
Advantages
Disadvantages
Crowding Out Effect
Conclusion
References

Introduction: Defining Deficit Spending

In order to gain an in-depth understanding of the economic outcomes of the Great Recession and other financial catastrophes, it is crucial to grasp the concept of deficit spending. The media has been the source of public dismay concerning the massive national debt, which continues to grow during the pandemic. NPR reports that the U.S. budget deficit soared to a record $3.1 trillion, following a massive surge in government spending aimed at containing the economic damage from the coronavirus pandemic (Zarroli, 2020, para. 1). A budget deficit is created when the government spends more money than it makes in corporate taxes and other sources of federal income. Thus, the deficit drives the overall amount of money a country has to borrow, which contributes to the national debt. In short, debt is the cumulative amount of money the government has borrowed throughout our nations history essentially, the net amount of all government deficits and surpluses, according to the Center on Budget and Policy Priorities (2020, para. 1). When the economy struggles, the government spends significantly more on safety net initiatives and collects less in taxes, which is why the deficit grows during a recession.

Advantages

Economists often recommend increasing deficit spending to put an end to a recession or moderate its impact on the economy. Deficit growth can play a beneficial automatic stabilizing role, helping moderate the downturns severity by cushioning the decline in overall consumer demand (Center on Budget and Policy Priorities, 2020, para. 5). Therefore, the governments excessive spending can be justified by the possibility of creating more jobs and helping the country recover from a recession much faster. Additionally, resulting in economic improvements, increased deficit spending positively affects the outlook for businesses, which leads to more investments (Thoma, 2011). Thoma (2011) notes that deficits allow to purchase infrastructure and spread the bills across time similar to the way households finance the purchase of a car or house, or the way local governments finance schools with bond issues (para. 2). Thus, it is important to recognize that deficits are not always bad for the economy although they contribute to the growth of the national debt. Increasing deficit spending can, in fact, help the economy recover and battle unemployment.

Disadvantages

Under certain circumstances, when the government increases deficits and continues to borrow large sums of money, deficit spending results in lower investments and inflation, which contribute to a vicious cycle of debt. Aside from recessions, the government can face a structural deficit even though the economy functions at its fullest capacity. This way, excessive government spending is unjustified, which means that borrowing has harmful effects on private credit markets and hurt economic growth over the long term (Center on Budget and Policy Priorities, 2020, para. 5). When it comes to deficits, another source of worry is their monetization leading to inflation (Thoma, 2011). As the government prints more money, an additional inflow of fresh currency into the private sector leads to market demand exceeding market supply. If people suddenly have more money to spend, they try to purchase items that are usually in limited quantities. Inflation is unlikely during a recession since there is an excess supply of goods (Thoma, 2011). Thus, it is evident that the outcome of increased deficit spending is positive only in the short-run, particularly if the economy is struggling.

Crowding Out Effect

To grasp the full scope of the potential impact of deficits, it is crucial to discuss the crowding out effect. Slavikova (2018) describes the effect as a macroeconomic concept that explains how increased central government activity negatively affects the involvement of other actors in a particular sector of an economy or a market (p. 96). Deficits cause interest rates to go up leading to deceased investment, which then translates into lower output and economic decline. Investment funds a limited, which is why when the government competes with the private sector for a share (to fund its excessive spending), interest rates increase significantly (Thoma, 2011). As a result, more government spending and less activity from the private sector leads to a less efficient utilization of resources. Hence, even if the economy is in recession, the government has to consider the negative effects of increased deficits, including the crowding out effect.

Conclusion

To sum it up, mass hysteria over the U.S. massive national debt is somewhat justified. The COVID-19 pandemic has been the overwhelming factor driving deficits higher. Increased deficit spending has been a rational response from the government to keep as many people employed as possible and help the economy recover. However, apart from playing a stabilizing role, deficit spending has many disadvantages, including lower investments, inflation, as well as the crowding out effect. Therefore, applying the deficit strategy during a recession in the short-run is beneficial. However, increasing deficit spending in order to reach long-term goals has many unjustified risks. Additionally, when the government borrows money from external (foreign governments) and internal (commercial banks) sources during good times, it can have harmful effects on the private sector and hinder economic development.

References

Center on Budget and Policy Priorities (2020). Policy basics: Deficits, debt, and interest. Web.

Slavikova, L. (2016). Effects of government flood expenditures: the problem of crowding-out. Journal of Flood Risk Management, 11(1), 95104. Web.

Thoma, M. (2011). Government deficits: The good, the bad, and the ugly. CBS News. Web.

Zarroli, J. (2020). $3.1 trillion: Pandemic spending drives the federal budget deficit to a record. NPR. Web.

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