Deficit spending is the amount by which a government, private company, or individual's spending exceeds income over a particular period of time, also called simply "deficit," or "budget deficit," the opposite of budget surplus. A budget deficit occurs when an Entity (often a Government) spends more Money than it takes in
When the expenditures of a government (its purchases of goods and services, plus its transfers (grants) to individuals and corporations) are greater than its tax revenues, it creates a deficit in the government budget; such a deficit is known as deficit spending. In business revenue or revenues is Income that a company receives from its normal business activities usually from the sale of goods and services A budget deficit occurs when an Entity (often a Government) spends more Money than it takes in This therefore causes the government to borrow capital from the 'world market', increasing further debt.
The opposite of a budget deficit is a budget surplus; in this case, tax revenues exceed government purchases and transfer payments. A budget deficit occurs when an Entity (often a Government) spends more Money than it takes in
Following John Maynard Keynes, many economists recommend deficit spending in order to moderate or end a recession, especially a severe one. John Maynard Keynes 1st Baron Keynes CB (ˈkeɪnz "cains" (5 June 1883 &ndash 21 April 1946 was a British Economist whose ideas An economist is an expert in the Social science of Economics. A recession is a contraction phase of the Business cycle. The U When the economy has high unemployment, an increase in government purchases creates a market for business output, creating income and encouraging increases in consumer spending, which creates further increases in the demand for business output. (This is the multiplier effect). In economics the multiplier effect refers to the idea that an initial spending rise can lead to an even greater increase in National income. This raises the real gross domestic product (GDP) and the employment of labor, all else constant lowering the unemployment rate. (The connection between demand for GDP and unemployment is called Okun's Law. Economics, Okun's law, named after Economist Arthur Okun who proposed the relationship in 1962 (Prachowny 1993 describes an inverse relationship between ) Cutting personal taxes and/or raising transfer payments can have similar expansionary effects, though most economists would say that such policies have weaker effects. Which method has a better stimulative economic effect is a matter of debate.
The increased size of the market, due to government deficits, can further stimulate the economy by raising business profitability and spurring optimism, which encourages private fixed investment in factories, machines, and the like to rise. This accelerator effect stimulates demand further and encourages rising employment. The accelerator effect in economics refers to a positive effect on private Fixed investment of the growth of the market economy (measured e
Similarly, running a government surplus or reducing its deficit reduces consumer and business spending and raises unemployment. This can lower the inflation rate. Any use of the government deficit to steer the macro-economy is called fiscal policy. Fiscal policy, taking the scope of Budgetary policy, refers to government policy that attempts to influence the direction of the economy through changes in government taxes
A deficit does not simply stimulate demand. If private investment is stimulated, that increases the ability of the economy to supply output in the long run. In Economics, potential output (also referred to as "natural gross domestic product" refers to the highest level of real Gross Domestic Product Also, if the government's deficit is spent on such things as infrastructure, basic research, public health, and education, that can also increase potential output in the long run. Finally, the high demand that a government deficit provides may actually allow greater growth of potential supply, following Verdoorn's Law. Verdoorn's Law is named after Dutch economist Jake Verdoorn. In Economics, this law pertains to the relationship between the growth of output and the growth of
There is, however, a danger that deficit spending may create inflation -- or encourage existing inflation to persist. In economics inflation or price inflation is a rise in the general level of prices of goods and services over a period of time (In the United States, this is seen most clearly when Vietnam-war era deficits encouraged inflation. The United States of America —commonly referred to as the ) This is especially true at low unemployment rates (say, below 4% unemployment in the U. S. ). But government deficits are not the only cause of inflation: it can arise due to such supply-side shocks as the "oil crises" of the 1970s and inflation left over from the past (inflationary expectations and the price/wage spiral). If equilibrium is located on the classical range of the supply graph, an increase in government spending will lead to inflation without affecting unemployment. There must also be enough money circulating in the system to allow inflation to persist -- so that inflation depends on monetary policy. Monetary policy is the process by which the Government, Central bank, or monetary authority of a country controls (i the Supply of Money,
A government deficit also has an impact on the economy through the loanable funds market. When there isn't enough tax money to cover outlays, the government must borrow. This increases the demand for loanable funds and thus (ignoring other changes) pushes up interest rates. Rising interest rates can "crowd out" (discourage) fixed private investment spending, canceling out some or even all of the demand stimulus arising from the deficit -- and perhaps hurting long-term supply-side growth. But increased deficits also raise the amount of total income received, which raises the amount of saving done by individuals and corporations and thus the supply of loanable funds, lowering interest rates. Thus, crowding out is a problem only when the economy is already close to full employment (say, at about 4% unemployment) and the scope for increasing income and saving is blocked by resource constraints (potential output). In Macroeconomics, full employment is when all people looking for employment can find a job In Economics, potential output (also referred to as "natural gross domestic product" refers to the highest level of real Gross Domestic Product Despite a government debt that exceeded GDP in 1945, the U. S. saw the long prosperity of the 1950s and 1960s. The growth of the "supply side", it seems, was not hurt by the large deficits and debts.
A government deficit leads to increased government debt (often confusingly called the "national debt" or the "public debt"). In the U. S. , the government borrows by selling bonds (T-bills, etc. Treasury securities are Government bonds issued by the United States Department of the Treasury through the Bureau of the Public Debt. ) rather than getting loans from banks. The most important burden of this debt is the interest that must be paid to bond-holders, which restricts a government's ability to raise its outlays or cut taxes to attain other goals. Further, most of the government debt is owned by the wealthy, so that a rising debt can raise the demand for the funds supplied by the rich, encouraging income inequality.
Whether government deficits are good or bad cannot be decided without examining the specifics. Just as with borrowing by individuals or businesses, it can be good or bad. If the government borrows (runs a deficit) to deal with a severe recession (or depression), to help self-defense, or spends on public investment (in infrastructure, education, basic research, or public health), the vast majority of economists would agree that the deficit is bearable, beneficial, and even necessary. If, on the other hand, the deficit finances wasteful expenditure or current consumption, most would recommend tax hikes, transfer cuts, and/or cuts in government purchases to balance the budget.
Not all government deficits are intentional, a result of policy decisions. When an economy goes into a recession (say, due to monetary policy), deficits usually rise, at least in the U. S. and other large, rich, countries: with less economic activity, a relatively progressive tax system implies that tax revenues automatically fall. Similarly, transfer payments such as unemployment insurance benefits and food stamp grants rise.
Most economists agree that raising taxes or cutting government spending (or both) is a big mistake in this situation: U. S. President Herbert Hoover made the Great Depression greater by raising taxes (and cutting demand further) in the early 1930s. Herbert Clark Hoover (August 10 1874 &ndash October 20 1964 was the thirty-first President of the United States (1929–1933 Instead, he should have relied on the increased deficit to moderate the recession. This is called automatic (or built-in) stabilization. (Similarly, a rise in GDP and employment automatically causes the government deficit to shrink in size, discouraging over-heating and inflation. )
Most economists favor the use of automatic stabilization over active or discretionary use of deficits to fight mild recessions (or surpluses to combat inflation). Active policy-making takes too long for politicians to institute and too long to affect the economy. Often, the medicine ends up affecting the economy only after its disease has been cured, leaving the economy with side-effects such as inflation. For example, President John F. Kennedy proposed tax cuts in response to the high unemployment of 1960, but these were instituted only in 1964 and impacted the economy only in 1965 or 1966 and encouraged inflation then, reinforcing the effect of Vietnam war spending. John Fitzgerald "Jack" Kennedy (May 29 1917&ndashNovember 22 1963 often referred to by his initials JFK, was the thirty-fifth President of The vast majority of economists are now in favor of monetary policy to replace active use of deficits or surpluses. Monetary policy is the process by which the Government, Central bank, or monetary authority of a country controls (i the Supply of Money,