Deficit spending refers to the spending of funds more than the income. In government, deficit spending occurs when the government expenditure exceed the revenues collected over a specified fiscal period (Investopedia, 2016b). An important note on government deficit spending is that it begins at the budgeting stage where the government plans to spend more than it expects to get in revenues. The consequence of this is that the government has to borrow even with the achievement of the highest estimates in revenue collection. The government finances the deficit through two main ways. Traditionally, the major method of meeting the government deficit is by borrowing internally (Investopedia, 2016b). This is accomplished through the sale of public securities. In the short period of up to one year, the government borrows from the public through the sale of treasury bills. On the other hand, there are the treasury bonds through which the government borrows long-term finances to fund the deficit. The second approach is through the use of monies borrowed from the international markets. The government can achieve international borrowing in many ways. The easiest has always been through bilateral funds extensions between two governments. Secondly, the government can float a bond in the international market, and when such a bond gets denominated in a currency other than the local currency, it gets referred to as a Eurobond. Considering the mechanisms of raising funds to fund the deficit, various advantages and disadvantages accrue from deficit spending and these will be the subject of the following few paragraphs.
Starting with the advantages, Keynesian economists believe that deficit spending stimulates the economy. According to Keynesian economists, deficit spending is positively correlated with the gross domestic product which loosely means that increases in deficit help in increasing the growth in the GDP. However, John Maynard Keynes also asserted the position that the main objective of deficit spending is to prevent unemployment or reverse rising unemployment. Keynes asserted the position that deficit spending has a direct impact on the reduction of unemployment and that the growth in the economy is a secondary impact of deficit spending. Drawing from Keynes assertions, growth in the economy as a result of increased government spending arises from the multiplier effect under which every $1 spent by the government results in more than a $1 increase in the total economic output (Wang & Wen, 2013). There have been several studies on this theoretical perspective with most of the studies being inconclusive. However, studies have shown that deficit spending stimulates consumption in the economy hence helping nations out of recessions and also helping in reversing depressions.
Looking at the disadvantages, deficit spending is criticized mainly by classical economists who argue that the advantages asserted by Keynesian economists are elusive. This is because the consistent deficits result in ballooning debt levels. These debts come with additional costs regarding interest on the debt. To meet the debt obligations, the government may be forced to consider means of repayment and these include the need to raise taxes. At times, deficit spending results in increased inflationary pressure and the government may again be forced to pursue inflationary monetary policies. Thirdly, the increasing debt levels compared to the conditions of the economy increase the risk of default on the government debt obligations (Investopedia, 2016b). It is important to note herein that these were observed in the case of Greece.
Other than the above-described disadvantages there is the problem of crowding out effect. Crowding out effect refers to an economic framework stipulating that increases in government borrowing to drive spending in the public sector has the potential to drive down or even eliminate the private sector borrowing capacity and consequently private sector borrowing. Rationally, this happens because as the government increases its deficit spending, it borrows more from the local debt markets. The lenders in the local markets are likely to lend more to the government owing to the low risk associated with lending to the government as compared to lending to the private sector. The implications of this are that the spending in public sector increases while the spending in the private sector reduces due to capital limitations. The lower spending in the private sector leads to lower production and the lower output leads to rises in the levels of unemployment as the private sector rushes to cut costs. The implications are that the benefits of economic stimulus programs launched under deficit spending are eliminated (Investopedia, 2016a). The government revenues reduce gradually as the incomes of private sector reduce and there arises the need for the government to borrow more leading to a vicious cycle of borrowing and crowding out. Considering this, deficit spending is discouraged.
In conclusion, this paper discusses deficit spending by the government. Deficit spending involves the spending finances more than what the government collects in revenues. Deficit spending is supported by Keynesian economists who believe that it has direct implications on the reduction of unemployment in the economy and indirect implications on positive growth of the economy. On the other hand, deficit spending increases debt levels, may lead to the need for higher taxes in the economy and also leads to the crowding out effect. Based on this understanding, I believe that deficit spending in periods of up to five years helps economic growth. However, beyond this period deficit spending becomes consistent and hinders long-term economic growth in the economy.
References
Investopedia. (2016a). Crowding Out Effect. Retrieved from http://www.investopedia.com/terms/c/crowdingouteffect.asp
Investopedia. (2016b). Deficit Spending. Retrieved from http://www.investopedia.com/terms/d/deficit-spending.asp
Wang, X., & Wen, Y. (2013). Multiplier effects of government spending: a tale of china. In Economic Dynamics series 2013 Meeting Paper (No. 214).
