Advantages And Disadvantages Of Deficit Spending
Deficit spending and the Crowding Out Effect
Deficit spending occurs when expenditures exceed an economies income or revenue from taxes. The concept is most associated with Governments however; it does apply to individuals also. This paper will analyze deficit spending, advantages, and disadvantages. In either case of advantage or disadvantage, deficit spending has multiple effects on economies and full of controversy. Hassan, M., Nassar, R., & Liu, C. identifies “The relationship between government deficit spending and the growth domestic product is of extreme importance for economic policy making, especially in times of economic downturns as has been experienced in the US and around the world in recent years” (Hassan, M., et al., pg. 103 2014). Other effects such as higher interest rates cause great concerns, concerns such as the Crowding out Effect. This paper will focus …show more content…
on Government deficit spending or Fiscal Policy to include the effects of federal borrowing on the economy that leads to problems like the Crowding Out Effect.
The advantages of deficit spending are it can be use to stimulate the economy or pull it out of a recession.
Deficit spending during a recession can come to the aide of society through programs like welfare and unemployment. Deficit spending allows governments to work around other economic challenges like raising taxes to generate income. A raise in taxes cause the individuals have less disposable income. To put that into to perspective the US already has the highest statutory tax rate so raising it more has pro and cons as well. By increasing spending it can stimulate employment thus naturally increases the amount of consumer spending and in turn generate natural income. John Maynard Keynes identifies “Aggregate expenditure as being key to economic activity” (as cited in Petroffs macroeconomics). A good factual example of this was the increase of defense spending during World War II the U.S was able to recover from the Great Depression. A key point here is if firms know that the government is start purchasing certain items then they will start producing them thus Aggregate
demand.
Disadvantages of deficit spending range from the obvious which is it increase the national debt, all the way to creating trade imbalances. A big problem with deficit spending is that debt grows too large to pay back, thus the Government will end up defaulting on the loan. Deficit spending causes the price to invest to go up i.e. interest rates; it increases the overall aggregate demand. These problems affect all levels of the market and can easily trigger unbalances; in essence, it can create an unstable situation that discourages lenders from offering loans, borrowers from applying for loans. The scenario where federal borrowing drives up interest rates leads me to my next topic, which is the crowding out effect.
The Crowding Out Effect is a result of expansionary Government fiscal policy, or increased deficit spending. Crowding out effects investments and consumption because of deficit spending and increase aggregate demand for loanable funds, thus interest rates increase to the point that it creates an undesirable situation for small business to invest. This fickle area because the effects can be the opposite of what the government wanted to achieve. Decreases in private investment and lack of investment can really hinder the long run.
In conclusion, deficit spending has both pros and cons for an economy. Whether it be to stimulate or slow down, deficit spending will affect the health a nation. When the government increases deficit spending, it deters private investors from investing by crowding them out. The challenge for governments is to find that appropriate level or balance spending. Deficit spending is a good tool for governments to use during times they need to slow down or speed up the economy. Governments should be extremely careful when choosing to apply deficit spending for the health of economy. Economist overall concur that deficit spending is necessary to stabilize economic growth.
Deficit spending occurs when expenditures exceed an economies income or revenue from taxes. The concept is most associated with Governments however; it does apply to individuals also. This paper will analyze deficit spending, advantages, and disadvantages. In either case of advantage or disadvantage, deficit spending has multiple effects on economies and full of controversy. Hassan, M., Nassar, R., & Liu, C. identifies “The relationship between government deficit spending and the growth domestic product is of extreme importance for economic policy making, especially in times of economic downturns as has been experienced in the US and around the world in recent years” (Hassan, M., et al., pg. 103 2014). Other effects such as higher interest rates cause great concerns, concerns such as the Crowding out Effect. This paper will focus …show more content…
on Government deficit spending or Fiscal Policy to include the effects of federal borrowing on the economy that leads to problems like the Crowding Out Effect.
The advantages of deficit spending are it can be use to stimulate the economy or pull it out of a recession.
Deficit spending during a recession can come to the aide of society through programs like welfare and unemployment. Deficit spending allows governments to work around other economic challenges like raising taxes to generate income. A raise in taxes cause the individuals have less disposable income. To put that into to perspective the US already has the highest statutory tax rate so raising it more has pro and cons as well. By increasing spending it can stimulate employment thus naturally increases the amount of consumer spending and in turn generate natural income. John Maynard Keynes identifies “Aggregate expenditure as being key to economic activity” (as cited in Petroffs macroeconomics). A good factual example of this was the increase of defense spending during World War II the U.S was able to recover from the Great Depression. A key point here is if firms know that the government is start purchasing certain items then they will start producing them thus Aggregate
demand.
Disadvantages of deficit spending range from the obvious which is it increase the national debt, all the way to creating trade imbalances. A big problem with deficit spending is that debt grows too large to pay back, thus the Government will end up defaulting on the loan. Deficit spending causes the price to invest to go up i.e. interest rates; it increases the overall aggregate demand. These problems affect all levels of the market and can easily trigger unbalances; in essence, it can create an unstable situation that discourages lenders from offering loans, borrowers from applying for loans. The scenario where federal borrowing drives up interest rates leads me to my next topic, which is the crowding out effect.
The Crowding Out Effect is a result of expansionary Government fiscal policy, or increased deficit spending. Crowding out effects investments and consumption because of deficit spending and increase aggregate demand for loanable funds, thus interest rates increase to the point that it creates an undesirable situation for small business to invest. This fickle area because the effects can be the opposite of what the government wanted to achieve. Decreases in private investment and lack of investment can really hinder the long run.
In conclusion, deficit spending has both pros and cons for an economy. Whether it be to stimulate or slow down, deficit spending will affect the health a nation. When the government increases deficit spending, it deters private investors from investing by crowding them out. The challenge for governments is to find that appropriate level or balance spending. Deficit spending is a good tool for governments to use during times they need to slow down or speed up the economy. Governments should be extremely careful when choosing to apply deficit spending for the health of economy. Economist overall concur that deficit spending is necessary to stabilize economic growth.