Deficit spending: economic benefits and disadvantages

Deficit Spending

What is deficit spending and how does it work

Deficit spending takes place when the government expenditures surpass the government revenues in a fiscal period, which in turn increases government debt balance. This surplus spending has to be financed through borrowing, more often from global financing establishments and foreign governments. On one hand, the augmented government spending can facilitate stimulate the economy taking into account more money flows in. On the other hand, this can be detrimental as increased government borrowing can lead to higher rates of interest. This implies that deficit spending is causal to both, benefits as well as disadvantages (Investopedia, 2016).

Disadvantages

Deficit spending does have its disadvantages. One of the key shortcomings is that it leads to a decrease in investments. When a government's deficit spending continues to increase, the level of debt will largely amplify leading to further recession. The inference of this is that the government will have fewer funds to spend on infrastructure and will dissuade investors from undertaking business in the nation. Secondly, deficit spending can lead to a bad economy. In the course of a deficit period, a nation characteristically has no savings taking into account the fact that they have to place priority on paying off the debt amount and its interest. This means that in times of further crisis, the nation may not have funds and will be forced to further borrow from other countries or other financial establishments such as World Bank. In turn, this gives rise to a vicious cycle (Mitchell, 2005). Another detrimental impact is the inclination of the government administration to increase the taxes, decrease public services and augment prices of goods, which ultimately gives rise to inflation and a lower standard of living. Another downside of deficit spending is that it can risk national sovereignty. The countries and international financing establishments that provide funds to a nation in recession can make influence local conditions and enforce demands prior to approving loans. For instance, the government may be forced to alter its laws and policies on spending. What is more, this might force the nation to put up for sale land and other assets to service its debt (Green Garage, 2015).

Crowding-out Effect

Crowding out effect takes into account a circumstance when higher rates of interest give rise to a decline in private investment spending in the sense that it hampers the initial increase in overall investment spending. In particular, governments have the power and authority to borrow huge amounts of money, which in turn can have a significant impact on the real rate of interest, increasing it substantially. This has the influence of gripping the lending capability of the economy and of dissuading companies and businesses from participating in capital projects. Considering that privately held companies finance these sorts of projects partly or wholly, they become disheartened owing to the fact that the opportunity cost of borrowing funds has increased, causing customarily profitable project financed via loans to be cost exorbitant (Investopedia, 2016).

Conclusions: Do you believe that deficit spending helps or hinders short-term and long-term economic growth?

As discussed above, deficit spending has both positive and negative impacts. With respect to economic growth, deficit spending can both be beneficial and detrimental. In the short-term, fiscal spending has a positive impact on economic growth. Proper fiscal spending can give rise to valuable goods for instance infrastructure and education. The government can create jobs, road and railways. In addition, fiscal spending can increase economic growth by increasing the spending power of consumers. In doing so, there is an increase in spending from the consumers. However, in the long run, fiscal spending has a negative impact on economic growth. In particular, greater fiscal spending is detrimental to economic growth owing to the transference of supplementary resources from the industrious sector of the economy to government, which historically, utilizes them in a less efficient manner. In addition, the expansion of the public sector bring about complication in the endeavours to execute policies for increasing economic growth, for instance, basic tax reform and individual retirement accounts (Mitchell, 2005). Therefore, I believe that in the short run, deficit spending has a positive impact on economic growth whereas in the long run, deficit has a negative impact on economic growth.