Deficit spending
Encyclopedia
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.
Government deficit spending is a central point of controversy in economics, as discussed below.
position is that deficit spending is desirable and necessary as part of countercyclical
fiscal policy
, but that there should not be a structural deficit
: in an economic slump, government should run deficits, to compensate for the shortfall in aggregate demand
, but should run corresponding surpluses in boom times so that there is no net deficit over an economic cycle – a cyclical deficit only. This is derived from Keynesian economics
, and has been the mainstream economics view (in the Anglo-Saxon world especially) since Keynesian economics was developed and largely accepted in the Great Depression
in the 1930s.
The mainstream position is attacked from both sides – advocates of sound finance argue that deficit spending is always bad policy, while some Post-Keynesian economists, particularly Chartalists, argue that deficit spending is necessary, and not only for fiscal stimulus.
) reject Keynesianism and, in the strongest form, argue that government should always run a balanced budget
(and a surplus to pay down any outstanding debt), and that deficit spending is always bad policy.
Sound finance has some academic support, predominantly associated with the neoclassical
-inclined Chicago school of economics, and has significant political and institutional support, with all but one state of the United States (Vermont
is the exception) having a balanced budget amendment
to its state constitution, and the Stability and Growth Pact
of the European Monetary Union punishing government deficits of 3% of GDP or greater. Proponents of sound finance date back to Adam Smith
, founder of modern economics. Sound finance was the dominant position until the Great Depression, associated with the gold standard
and expressed in the Treasury View
that government fiscal policy was ineffective.
The usual argument against deficit spending, dating to Adam Smith, is that households should not run deficits – one should have money before one spends it, from prudence – and that what is correct for a household is correct for a nation and its government. A further argument is that debts must be repaid, and thus it is burdening future generations to run deficits today, for little or no gain.
A similar argument is that deficit spending today will require increased taxation in the future, thus burdening future generations – see generational accounting
for discussion. Others argue that because debt is both owed by and owed to private individuals, there is no net debt burden of government debt, just wealth transfer (redistribution) from those who owe debt (government, backed by tax payers) to those who hold debt (holders of government bonds).
A related line of argument, associated with the Austrian school of economics, is that government deficits are inflationary. Anything other than mild or moderate inflation is generally accepted in economics to be a bad thing. In practice this is argued to be because governments pay off debts by printing fiat money, increasing the money supply and creating inflation, and is taken further by some as an argument against fiat money and in favor of hard money
, especially the gold standard.
Chartalists argue that deficit spending is logically necessary because, in their view, fiat money
is created by deficit spending: one cannot collect fiat money in taxes before one has issued it and spent it, and the amount of fiat money in circulation is exactly the government debt
– money spent but not collected in taxes. In a quip, "fiat money governments are 'spend and tax', not 'tax and spend
'," – deficit spending comes first. Chartalists argue that nations are fundamentally different from households – governments in a fiat money system can issue liabilities to pay off debt, and thus (assuming they only have debt in their own currency), need not go bankrupt, unlike households, which cannot issue liabilities. This view is summarized as:
Continuing in this vein, Chartalists argue that a structural deficit is necessary for monetary expansion in an expanding economy: if the economy grows, the money supply should as well, which should be accomplished by government deficit spending. Private sector savings are equal to government sector deficits, to the penny. In the absence of sufficient deficit spending, money supply can increase by increasing financial leverage in the economy – the credit money
supply grows, while the base money supply remains unchanged or grows at a slower rate, and thus the ratio (leverage = credit/base) increases, which can lead to a credit bubble and a financial crisis
.
Chartalism is a small minority view in economics; while it has had advocates over the years, and influenced Keynes, who specifically credited it, it is categorically rejected or ignored by virtually all contemporary mainstream economists. A notable proponent was Ukrainian American economist Abba P. Lerner
, who founded the school of Neo-Chartalism, and advocated deficit spending in his theory of functional finance
. A contemporary center of Neo-Chartalism is the Kansas City School of economics.
Chartalists, like other Keynesians accept the paradox of thrift
, which argues that identifying behavior of individual households and the nation as a whole commits the fallacy of composition
; while the paradox of thrift (and thus deficit spending for fiscal stimulus) is widely accepted in economics, the Chartalist form is not.
An alternative argument for the necessity of deficits was given by celebrated American economist William Vickrey
, who argued that deficits were necessary to satisfy demand for savings in excess of what can be satisfied by private investment.
s, the government budget is said to be in deficit; government spending in excess of tax receipts is known as deficit spending. Governments usually issue Government bond
s to match their deficits. They can be bought by its Central Bank
through Quantitative easing
. Otherwise the debt issuance can increase the level of (i) public debt, (ii) private sector net worth, (iii) debt service (interest payments) and (iv) interest rates (See: "crowding out" below). Deficit spending may, however, be consistent with public debt remaining stable as a proportion of GDP, depending on the level of GDP growth.
The opposite of a budget deficit is a budget surplus; in this case, tax revenues exceed government purchases and transfer payments.
For the public sector to be in deficit implies that the private sector (domestic and foreign) is in surplus. An increase in public indebtedness must necessarily therefore correspond to an equal decrease in private sector net indebtedness. In other words, deficit spending permits the private sector to accumulate net worth.
On average, through the economic cycle, most governments have traditionally tended to run budget deficits, as can be seen from the large debt balances accumulated by governments across the world.
, many economist
s recommend deficit spending to moderate or end a recession
, especially a severe one. 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
). This raises the real gross domestic product
(GDP) and the employment of labour, and if all else is constant, lowers the unemployment rate. (The connection between demand for GDP and unemployment is called Okun's Law
.) Cutting personal taxes and/or raising transfer payments can have similar expansionary effects, though 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. Increase in government payroll has been shown to depress the economy in the long run.
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
.
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. 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
.
There is, however, a danger that deficit spending may create inflation
- or encourage existing inflation to persist. (In the United States
, this is seen most clearly when Vietnam-war era deficits encouraged inflation.) 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
.
(say, at about 4% unemployment) and the scope for increasing income and saving is blocked by resource constraints (potential output
). 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.) 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.
By contrast, other sources of tax revenue such as wealth tax
es, notably property tax
es, are not subject to recessions, though they are subject to asset price bubbles.
The reliance of California
on state income tax, rather than property tax, due to property taxes being limited by Proposition 13
, has been cited as an example of the dangers of an income tax-reliant tax system and a cause of the 2008–10 California budget crisis.
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 the increased debt encouraged inflation, reinforcing the effect of Vietnam war deficit spending.
Deficit financing also helps to minimize the substantial risks and costs of developing programs for the networks and gives studios initial benefits as well. The studio obtains the difference between production costs and licensing fees, which can now amount to millions of dollars for each season. If the network orders enough episodes of a show, the studios can then sell the series to other various markets. Deficit financing minimizes risks and costs of developing programs for networks.
Government deficit spending is a central point of controversy in economics, as discussed below.
Controversy
Government deficit spending is a central point of controversy in economics, with prominent economists holding differing views. The mainstream economicsMainstream economics
Mainstream economics is a loose term used to refer to widely-accepted economics as taught in prominent universities and in contrast to heterodox economics...
position is that deficit spending is desirable and necessary as part of countercyclical
Countercyclical
Countercyclical is a term used in economics to describe how an economic quantity is related to economic fluctuations. It is the opposite of procyclical. However, it has more than one meaning.-Meaning in policy making:...
fiscal policy
Fiscal policy
In economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....
, but that there should not be a structural deficit
Structural deficit
Structural deficit forms part of the public sector deficit. Structural deficit differs from cyclical deficit in that structural deficit exists even when the economy is at its potential....
: in an economic slump, government should run deficits, to compensate for the shortfall in aggregate demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
, but should run corresponding surpluses in boom times so that there is no net deficit over an economic cycle – a cyclical deficit only. This is derived from Keynesian economics
Keynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...
, and has been the mainstream economics view (in the Anglo-Saxon world especially) since Keynesian economics was developed and largely accepted in the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
in the 1930s.
The mainstream position is attacked from both sides – advocates of sound finance argue that deficit spending is always bad policy, while some Post-Keynesian economists, particularly Chartalists, argue that deficit spending is necessary, and not only for fiscal stimulus.
Sound finance
Advocates of sound finance (in the US known as fiscal conservatismFiscal conservatism
Fiscal conservatism is a political term used to describe a fiscal policy that advocates avoiding deficit spending. Fiscal conservatives often consider reduction of overall government spending and national debt as well as ensuring balanced budget of paramount importance...
) reject Keynesianism and, in the strongest form, argue that government should always run a balanced budget
Balanced budget
A balanced budget is when there is neither a budget deficit or a budget surplus – when revenues equal expenditure – particularly by a government. More generally, it refers to when there is no deficit, but possibly a surplus...
(and a surplus to pay down any outstanding debt), and that deficit spending is always bad policy.
Sound finance has some academic support, predominantly associated with the neoclassical
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...
-inclined Chicago school of economics, and has significant political and institutional support, with all but one state of the United States (Vermont
Vermont
Vermont is a state in the New England region of the northeastern United States of America. The state ranks 43rd in land area, , and 45th in total area. Its population according to the 2010 census, 630,337, is the second smallest in the country, larger only than Wyoming. It is the only New England...
is the exception) having a balanced budget amendment
Balanced Budget Amendment
A balanced-budget amendment is a constitutional rule requiring that the state cannot spend more than its income. It requires a balance between the projected receipts and expenditures of the government....
to its state constitution, and the Stability and Growth Pact
Stability and Growth Pact
The Stability and Growth Pact is an agreement among the 27 Member states of the European Union that take part in the Eurozone, to facilitate and maintain the stability of the Economic and Monetary Union...
of the European Monetary Union punishing government deficits of 3% of GDP or greater. Proponents of sound finance date back to Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...
, founder of modern economics. Sound finance was the dominant position until the Great Depression, associated with the gold standard
Gold standard
The gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard...
and expressed in the Treasury View
Treasury View
In macroeconomics, particularly in the history of economic thought, the Treasury view is the assertion that fiscal policy has no effect on the total amount of economic activity and unemployment, even during times of economic recession. This view was most famously advanced in the 1930s by the staff...
that government fiscal policy was ineffective.
The usual argument against deficit spending, dating to Adam Smith, is that households should not run deficits – one should have money before one spends it, from prudence – and that what is correct for a household is correct for a nation and its government. A further argument is that debts must be repaid, and thus it is burdening future generations to run deficits today, for little or no gain.
A similar argument is that deficit spending today will require increased taxation in the future, thus burdening future generations – see generational accounting
Generational accounting
Generational accounting is a relatively new method of national accounting for measuring redistribution of lifetime tax burdens across generations from social insurance, including social security and social health insurance...
for discussion. Others argue that because debt is both owed by and owed to private individuals, there is no net debt burden of government debt, just wealth transfer (redistribution) from those who owe debt (government, backed by tax payers) to those who hold debt (holders of government bonds).
A related line of argument, associated with the Austrian school of economics, is that government deficits are inflationary. Anything other than mild or moderate inflation is generally accepted in economics to be a bad thing. In practice this is argued to be because governments pay off debts by printing fiat money, increasing the money supply and creating inflation, and is taken further by some as an argument against fiat money and in favor of hard money
Hard money
Hard money may refer to:* Hard currency, globally traded currency that can serve as a reliable and stable store of value* Hard money donations to candidates for political office* Hard money currency policies...
, especially the gold standard.
Post-Keynesian economics
Conversely, some Post-Keynesian economists argue that deficit spending is necessary, either to create the money supply (Chartalism) or to satisfy demand for savings in excess of what can be satisfied by private investment.Chartalists argue that deficit spending is logically necessary because, in their view, fiat money
Fiat money
Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree. Where fiat money is used as currency, the term fiat currency is used.Fiat money originated in 11th...
is created by deficit spending: one cannot collect fiat money in taxes before one has issued it and spent it, and the amount of fiat money in circulation is exactly the government debt
Government debt
Government debt is money owed by a central government. In the US, "government debt" may also refer to the debt of a municipal or local government...
– money spent but not collected in taxes. In a quip, "fiat money governments are 'spend and tax', not 'tax and spend
Tax and spend
"Tax and Spend" is an epithet applied to politicians , programs, and opposing political philosophy by the American center-right, conservative, and libertarian movements. It does have another neutral, objective, connotation i.e. with regard to tax policy or fiscal policy but this usage is...
'," – deficit spending comes first. Chartalists argue that nations are fundamentally different from households – governments in a fiat money system can issue liabilities to pay off debt, and thus (assuming they only have debt in their own currency), need not go bankrupt, unlike households, which cannot issue liabilities. This view is summarized as:
- But it is hard to understand how the concept of "budget busting" applies to a government which, as a sovereign issuer of its own currency, can always create dollars to spend. There is, in other words, no budget to "bust". A national "budget" is merely an account of national spending priorities, and does not represent an external constraint in the manner of a household budget.
Continuing in this vein, Chartalists argue that a structural deficit is necessary for monetary expansion in an expanding economy: if the economy grows, the money supply should as well, which should be accomplished by government deficit spending. Private sector savings are equal to government sector deficits, to the penny. In the absence of sufficient deficit spending, money supply can increase by increasing financial leverage in the economy – the credit money
Credit money
Credit money is any claim against a physical or legal person that can be used for the purchase of goods and services. Examples of credit money include personal IOUs, and in general any financial instrument or bank money market account certificate, which is not immediately repayable in specie, on...
supply grows, while the base money supply remains unchanged or grows at a slower rate, and thus the ratio (leverage = credit/base) increases, which can lead to a credit bubble and a financial crisis
Financial crisis
The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these...
.
Chartalism is a small minority view in economics; while it has had advocates over the years, and influenced Keynes, who specifically credited it, it is categorically rejected or ignored by virtually all contemporary mainstream economists. A notable proponent was Ukrainian American economist Abba P. Lerner
Abba P. Lerner
Abba Ptachya Lerner was an American economist.Lerner was born on October 28, 1903 in Bessarabia . He grew up in a Jewish family, which emigrated to Great Britain when Lerner was three years old. Lerner grew up in the London East End. From the age of sixteen he worked as a machinist, a teacher in...
, who founded the school of Neo-Chartalism, and advocated deficit spending in his theory of functional finance
Functional finance
Functional finance is an economic theory proposed by Abba P. Lerner, based on effective demand principle and chartalism. It states that government should finance itself to meet explicit goals, such as taming the business cycle, achieving full employment, ensuring growth and low inflation.-...
. A contemporary center of Neo-Chartalism is the Kansas City School of economics.
Chartalists, like other Keynesians accept the paradox of thrift
Paradox of thrift
The paradox of thrift is a paradox of economics, popularized by John Maynard Keynes, though it had been stated as early as 1714 in The Fable of the Bees, and similar sentiments date to antiquity...
, which argues that identifying behavior of individual households and the nation as a whole commits the fallacy of composition
Fallacy of composition
The fallacy of composition arises when one infers that something is true of the whole from the fact that it is true of some part of the whole...
; while the paradox of thrift (and thus deficit spending for fiscal stimulus) is widely accepted in economics, the Chartalist form is not.
An alternative argument for the necessity of deficits was given by celebrated American economist William Vickrey
William Vickrey
William Spencer Vickrey was a Canadian professor of economics and Nobel Laureate. Vickrey was awarded the Nobel Memorial Prize in Economics with James Mirrlees for their research into the economic theory of incentives under asymmetric information...
, who argued that deficits were necessary to satisfy demand for savings in excess of what can be satisfied by private investment.
- Larger deficits, sufficient to recycle savings out of a growing gross domestic product (GDP) in excess of what can be recycled by profit-seeking private investment, are not an economic sin but an economic necessity.
Government deficits
When the outlay of a government (its purchases of goods and services, plus its transfers (grants) to individuals and corporations, in addition to its net interest payments) exceed its tax revenueRevenue
In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is referred to as turnover....
s, the government budget is said to be in deficit; government spending in excess of tax receipts is known as deficit spending. Governments usually issue Government bond
Government bond
A government bond is a bond issued by a national government denominated in the country's own currency. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country...
s to match their deficits. They can be bought by its Central Bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
through Quantitative easing
Quantitative easing
Quantitative easing is an unconventional monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective. A central bank buys financial assets to inject a pre-determined quantity of money into the economy...
. Otherwise the debt issuance can increase the level of (i) public debt, (ii) private sector net worth, (iii) debt service (interest payments) and (iv) interest rates (See: "crowding out" below). Deficit spending may, however, be consistent with public debt remaining stable as a proportion of GDP, depending on the level of GDP growth.
The opposite of a budget deficit is a budget surplus; in this case, tax revenues exceed government purchases and transfer payments.
For the public sector to be in deficit implies that the private sector (domestic and foreign) is in surplus. An increase in public indebtedness must necessarily therefore correspond to an equal decrease in private sector net indebtedness. In other words, deficit spending permits the private sector to accumulate net worth.
On average, through the economic cycle, most governments have traditionally tended to run budget deficits, as can be seen from the large debt balances accumulated by governments across the world.
Keynesian Effect
Following John Maynard KeynesJohn Maynard Keynes
John Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...
, many economist
Economist
An economist is a professional in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...
s recommend deficit spending to moderate or end a recession
Recession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...
, especially a severe one. 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
Multiplier (economics)
In economics, the fiscal multiplier is the ratio of a change in national income to the change in government spending that causes it. More generally, the exogenous spending multiplier is the ratio of a change in national income to any autonomous change in spending In economics, the fiscal...
). This raises the real gross domestic product
Gross domestic product
Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living....
(GDP) and the employment of labour, and if all else is constant, lowers the unemployment rate. (The connection between demand for GDP and unemployment is called Okun's Law
Okun's law
In economics, Okun's law is an empirically observed relationship relating unemployment to losses in a country's production first quantified by Arthur M. Okun. The "gap version" states that for every 1% increase in the unemployment rate, a country's GDP will be at an additional roughly 2% lower...
.) Cutting personal taxes and/or raising transfer payments can have similar expansionary effects, though 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
Accelerator effect
The accelerator effect in economics refers to a positive effect on private fixed investment of the growth of the market economy . Rising GNP implies that businesses in general see rising profits, increased sales and cash flow, and greater use of existing capacity...
stimulates demand further and encourages rising employment. Increase in government payroll has been shown to depress the economy in the long run.
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
In economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....
.
A deficit does not simply stimulate demand. If private investment is stimulated, that increases the ability of the economy to supply output
Potential output
In economics, potential output refers to the highest level of real Gross Domestic Product output that can be sustained over the long term. The existence of a limit is due to natural and institutional constraints...
in the long run. 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
Verdoorn's law is named after Dutch economist, Petrus Johannes Verdoorn. In economics, this law pertains to the relationship between the growth of output and the growth of productivity. According to the law, faster growth in output increases productivity due to increasing returns...
.
There is, however, a danger that deficit spending may create inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
- or encourage existing inflation to persist. (In the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, this is seen most clearly when Vietnam-war era deficits encouraged inflation.) 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
Price/wage spiral
In macroeconomics, the price/wage spiral represents a vicious circle process in which different sides of the wage bargain try to keep up with inflation to protect real incomes. Thus, this process is one possible result of inflation...
). 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
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
.
Loanable funds
Many economists believe government deficits influence the economy through the loanable funds market, whose existence Chartalists and other Post-Keynesians dispute. Government borrowing in this market 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 employmentFull employment
In macroeconomics, full employment is a condition of the national economy, where all or nearly all persons willing and able to work at the prevailing wages and working conditions are able to do so....
(say, at about 4% unemployment) and the scope for increasing income and saving is blocked by resource constraints (potential output
Potential output
In economics, potential output refers to the highest level of real Gross Domestic Product output that can be sustained over the long term. The existence of a limit is due to natural and institutional constraints...
). 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.) 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.
"Crowding out"
Usually when economists use the term "crowding out" they are referring to the government spending using up financial and other resources that would otherwise be used by private enterprise. However, some commentators use "crowding out" to refer to government providing a service or good that would otherwise be a business opportunity for private industry.Government deficits: good or bad?
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 cuts to stimulate private investment, transfer cuts, and/or cuts in government purchases to balance the budget.Unintentional deficits
Not all national 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 based on economic activity (income, expenditure, or transactions) implies that tax revenues automatically fall. Similarly, transfer payments such as unemployment insurance benefits and food stamp grants rise.By contrast, other sources of tax revenue such as wealth tax
Wealth tax
A wealth tax is generally conceived of as a levy based on the aggregate value of all household holdings actually accumulated as purchasing power stock , including owner-occupied housing; cash, bank deposits, money funds, and savings in insurance and pension plans; investment in real estate and...
es, notably property tax
Property tax
A property tax is an ad valorem levy on the value of property that the owner is required to pay. The tax is levied by the governing authority of the jurisdiction in which the property is located; it may be paid to a national government, a federated state or a municipality...
es, are not subject to recessions, though they are subject to asset price bubbles.
The reliance of California
California
California is a state located on the West Coast of the United States. It is by far the most populous U.S. state, and the third-largest by land area...
on state income tax, rather than property tax, due to property taxes being limited by Proposition 13
California Proposition 13 (1978)
Proposition 13 was an amendment of the Constitution of California enacted during 1978, by means of the initiative process. It was approved by California voters on June 6, 1978. It was declared constitutional by the United States Supreme Court in the case of Nordlinger v. Hahn,...
, has been cited as an example of the dangers of an income tax-reliant tax system and a cause of the 2008–10 California budget crisis.
Automatic vs. active deficit policies
Most economists favor the use of automatic stabilizationAutomatic stabilizer
In macroeconomics, automatic stabilizers describes how modern government budget policies, particularly income taxes and welfare spending, act to dampen fluctuations in real GDP....
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
John F. Kennedy
John Fitzgerald "Jack" Kennedy , often referred to by his initials JFK, was the 35th President of the United States, serving from 1961 until his assassination in 1963....
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 the increased debt encouraged inflation, reinforcing the effect of Vietnam war deficit spending.
Deficit financing
Deficit financing is a bunch of most programs through paying the studio that creates a show a license fee in exchange for the right to air the show. A major broadcast network will ask a program producer to share in the financial risk when considering adopting a new program to its schedule; at least for the first season of the series. The deficit is essentially the network not paying the full total of the cost to create a pilot program of the cost of creating a few episodes of a new program.Deficit financing also helps to minimize the substantial risks and costs of developing programs for the networks and gives studios initial benefits as well. The studio obtains the difference between production costs and licensing fees, which can now amount to millions of dollars for each season. If the network orders enough episodes of a show, the studios can then sell the series to other various markets. Deficit financing minimizes risks and costs of developing programs for networks.
See also
- Functional financeFunctional financeFunctional finance is an economic theory proposed by Abba P. Lerner, based on effective demand principle and chartalism. It states that government should finance itself to meet explicit goals, such as taming the business cycle, achieving full employment, ensuring growth and low inflation.-...
- Deficit (disambiguation)
- Public debt
- Balanced Budget AmendmentBalanced Budget AmendmentA balanced-budget amendment is a constitutional rule requiring that the state cannot spend more than its income. It requires a balance between the projected receipts and expenditures of the government....
- Keynsian economics
- Fiscal policyFiscal policyIn economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....