Effects of Long-Term Deficit Spending
The Effects of Long-term Deficit Spending
ECO 203 Prof. Kristian Morales October 3, 2011
The Effects of Long-term Deficit Spending
In times of hardship, economist Maynard Keynes noted that the federal government not only has a responsibility to help revive the economy, but is often the only solution when a recession grows deep enough. He argued that the basic problem of a severe recession is a lack of investment on the part of business despite low interest rates. The answer when neither business nor consumers are able to awaken the economy is that the government needs to step in and encourage investment through borrowing and spending. Government spending can reactivate a dull economy and spur on new investment and growth. When an economy is sluggish, the government spends monies in excess of collected tax revenues through deficit spending, Keynesian economists typically argue that deficit spending is necessary in an economic downturn. Deficit spending allows a government to offset shortfalls in aggregate demand, and paying these deficits down during times of economic prosperity (Buchanan, 2009). While a big deficit may ease short-term economic pain, economists generally agree that high budget deficits today will reduce the growth rate of the economy in the future with higher taxes, interest payments, and an increasing reliance on foreign capital. Economic growth automatically reduces deficits by increasing tax revenues and reducing transfer payments like unemployment benefits and other spending. As the economy grows the deficits falls as revenues increase and the debt becomes easier to pay (Sharing the pain; dealing with fiscal deficits, 2010). Conversely, when the economy is in a slump, the government in response will increase spending both in response to increased unemployment and as a matter of monetary policy to invigorate investment. This increased spending is funded through debt the government takes. In many ways, it is similar to how a
ECO 203 Prof. Kristian Morales October 3, 2011
The Effects of Long-term Deficit Spending
In times of hardship, economist Maynard Keynes noted that the federal government not only has a responsibility to help revive the economy, but is often the only solution when a recession grows deep enough. He argued that the basic problem of a severe recession is a lack of investment on the part of business despite low interest rates. The answer when neither business nor consumers are able to awaken the economy is that the government needs to step in and encourage investment through borrowing and spending. Government spending can reactivate a dull economy and spur on new investment and growth. When an economy is sluggish, the government spends monies in excess of collected tax revenues through deficit spending, Keynesian economists typically argue that deficit spending is necessary in an economic downturn. Deficit spending allows a government to offset shortfalls in aggregate demand, and paying these deficits down during times of economic prosperity (Buchanan, 2009). While a big deficit may ease short-term economic pain, economists generally agree that high budget deficits today will reduce the growth rate of the economy in the future with higher taxes, interest payments, and an increasing reliance on foreign capital. Economic growth automatically reduces deficits by increasing tax revenues and reducing transfer payments like unemployment benefits and other spending. As the economy grows the deficits falls as revenues increase and the debt becomes easier to pay (Sharing the pain; dealing with fiscal deficits, 2010). Conversely, when the economy is in a slump, the government in response will increase spending both in response to increased unemployment and as a matter of monetary policy to invigorate investment. This increased spending is funded through debt the government takes. In many ways, it is similar to how a
References: Buchanan, N. (2009, July 16). Everyone seems to agree that budget deficits are harmful. Can they all be wrong? Retrieved September 30, 2010 from http://www.findlaw.com/ website: http://writ.news.findlaw.com/buchanan/20090716.html Hubbard, S. (2003, August). Do budget deficits affect long-term interest rates? U.S. federal budget deficits are back big time. What will be their long-term consequences? Seven big thinkers enter the ring, gloves up . Retrieved September 30, 2010, from http://findarticles.com/p/articles/mi_m2633/is_3_17/ai_106423903/ website: http://findarticles.com/ Kotlikoff, L.. (2011). Fixing social secrity - what would Bismarck? National Tax Journal,1 64(2), 415-428. Retrieved October 1, 2011, from ABI/INFORM Global. (Document ID: 2375411911). Morrison, W. M., & Labonte, M. (2009, July 30). China’s holdings of U.S. securities: implications for the U.S. economy (RL34314). Retrieved from Congressional Research Service website: http://www.fas.org/sgp/crs/row/RL34314.pdf Pettinger, T. (2010, June 7). Monetary policy vs fiscal policy [Web log post]. Retrieved from http://www.economicshelp.org/: http://www.economicshelp.org/blog/2253/economics/monetary-policy-vs-fiscal-policy/ Sharing the pain; dealing with fiscal deficits. (2010, March). The Economist, 394(8672), 95-98. Retrieved October 1, 2011, from ABI/INFORM Global. (Document ID: 1978193741). Slivinski, S. (2010, July). Do deficits matter? And, if so, how? (Region focus, second quarter, 2010). Retrieved from Richmond Fed website: http://www.richmondfed.org/publications/research/region_focus/2010/q2/pdf/cover_story.pdf