About Deficit spending

The budget deficit, also referred to as deficit expenditure, is frequently taken to represent total debt. Budget deficit, on the other hand, refers to the annual accruing debt owing by the government. Entire debt, on the other hand, refers to the total amount borrowed and owed by the government (Perry, 2014). As a result, deficit spending occurs when total government spending exceeds total tax receipts. Deficit spending usually occurs during economic recessions due to the increase in expenditures as a result of automatic stabilizers like unemployment benefits, Medicaid programs and voluntary fiscal policies which lead to government borrowing from external sources to fund the increasing government expenditures

In most scenarios citizens and economists, however, ask themselves why governments often opt for deficit spending that ultimately increases the public debt instead of raising revenue from taxes. However, despite the fact that deficit spending may increase public debt, governments may decide to borrow because of various advantages associated with borrowing compared to raising taxes. One of the reasons why deficit spending is more advantageous than raising taxes can be expressed during economic recessions (Chryistal & Thornton, 1988). Studies show that total incomes within a country decline during the recession period which leads to higher rates of unemployment and higher government expenditure in subsidizing for essential goods and services. Governments will, therefore, prefer deficit spending by borrowing to subsidize on goods and services than raising taxes which will diminish the economy because citizens will be struggling to meet the higher taxes (Chryistal & Thornton, 1988). Deficit spending will, therefore, be beneficial to the economy because it eases recession by increasing the employment rate and government spending through external borrowing which leads to greater output within an economy.

Another advantage of deficit spending is that it contributes to stable output when the economy on its own cannot meet the overall demand at a level that could match full employment level (Chryistal & Thornton, 1988). If there are prolonged levels of unemployment in an economy, the demand for goods and services will be low leading to a low output; the government will, therefore, opt for deficit spending to make up for the low economic output. Therefore deficit spending helps to match output to full employment levels during the periods when the rates of unemployment in a country are high, and output is low (Chryistal & Thornton, 1988).

Despite the various advantages arising from deficit spending, there also exist disadvantages. Firstly as deficit spending leads to an increase of the public debt, and therefore consequently the cost of paying for the public debt also increases, which ultimately leads to the increase of the cost of both essential and non-essential goods and services (Perry, 2014). The second disadvantage of deficit spending arises due to the unwillingness of lenders to lend to individuals or organizations due to market uncertainties that may make borrowers unable to repay their debts (Perry, 2014). For instance; governments may use deficit spending to invest and boost the economy’s productivity. However, it is not guaranteed that the investment will boost the economy and therefore employment will not be guaranteed, and there is no assurance that the economy will change for the better. Studies show that the non-assurance of boosting the economy through deficit spending leads to uncertainty among lenders about the probability of their money being repaid and therefore charges higher interest rates to mitigate the risk of nonpayment. Due to high-interest rates charged by lenders, repayment often becomes costly and unmanageable and therefore could further deflate the economy (Perry, 2014). For example, according to Perry, Greece was a victim of high-interest rates and doubts from lenders of its ability to repay debts during the financial crisis that hit the European countries recently due to its low growth and high debt levels.

Another disadvantage of deficit spending is in the aspect of the modalities of repaying the debts. There are two common ways of repaying debts, that is, tax revenues and monetizing the debt (Perry, 2014). For instance, countries may increase taxes to repay accrued debts that arise from deficit spending. This, however, has a significant effect on the economy since it will reduce consumption and discourage investments. Additionally, monetizing the debt which simply means printing money is another unhealthy way of repaying debts. It is argued by economists that printing money to pay off accrued debts leads to an increase in money supply in the economy which creates inflation (Perry, 2014)

Crowding out occurs when private economic activities are replaced by public economic activities (Buiter, 1976). For instance, if an increase in government spending financed by taxes and external borrowings exceeds private investments, the private sector is therefore crowded out by the public sector. Therefore the level of crowding out can be described as the ratio of change in public economic activities to the ratio of change of private economic activities (Buiter, 1976). For instance, studies show that in many countries the level of government spending is higher than private investments hence the crowding out effect (Carlson & Spencer, 1975). This is mostly experienced in developed countries than in developing countries because, in developed countries, consumption expenditure is funded by governments through taxes and external borrowing. Therefore an increase in taxes will lead to a decrease in investments leading to a decline in private investments hence crowding out of private investments (Carlson & Spencer, 1975).

Deficit spending occurs when the government expenditure exceeds the revenue raised. Governments, however, opt for deficit spending to sponsor programs which it expects to boost the economies. The funds spent on deficit spending are usually borrowed from external sources leading to an increase in public debt. Additionally, the borrowed funds are issued on higher interest rates and therefore repaying the debts becomes costly to the borrower and leads to an increase in the cost of essential goods services. However; most people have a negative opinion about deficit spending because of the burden of repaying the accrued debts. Despite the debts, governments, however, borrow to meet the budget deficits to ease economic recessions.

References

Buiter, W. H. (1977). Crowding out’ and the Effectiveness of fiscal policy. Journal of Public Economics, 7(3), 309-328. doi:10.1016/0047-2727(77)90052-4

Carlson, K. M., & Spencer, R. W. (1975).Crowding out and its Critics. Federal Reserve Bank of St. Louis Review,1-17.

Chrystal, K. A. (1988). The Macroeconomic Effects of Deficit Spending: A Review. Federal Reserve Bank of St. Louis Review, 48-60. Retrieved from https://files.stlouisfed.org/files/htdocs/publications/review/88/11/Deficit_Nov_Dec1988.pdf

Mahmoudzadeh, M., Sadeghi, S., & Sadeghi, S. (2013). Fiscal Spending and Crowding out Effect: A Comparison between Developed and Developing Countries. Institutions and Economies, 5(1), 31-40.

Perry, N. (2014). Debt and Deficits: Economic and Political Issues. Retrieved from Global Development And Environment Institute, Tufts University website: http://www.ase.tufts.edu/gdae/education_materials/modules/DebtAndDeficits.pdf

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