What Is Deficit Spending?
Let me explain deficit spending to you directly: it's when a government's expenditures go beyond its revenues in a given period, creating a budget deficit. You'll often hear this term in the context of a Keynesian strategy, where the government borrows to spend more, aiming to boost demand and get the economy moving.
Key Takeaways
- Deficit spending occurs when government spending exceeds its revenue.
- Deficit spending often refers to intentional excess spending meant to stimulate the economy.
- British economist John Maynard Keynes is the most well-known proponent of deficit spending as a form of economic stimulus.
Understanding Deficit Spending
You should know that the idea of using deficit spending for economic stimulus comes from John Maynard Keynes, the British economist. In his 1936 book 'The General Theory of Employment, Interest and Money,' he made the case that during a recession or depression, falling consumer spending can be offset by ramping up government spending.
To Keynes, keeping aggregate demand steady—that total spending from consumers, businesses, and the government—is essential to avoid prolonged high unemployment. This can spiral downward, with weak demand leading to more layoffs, which weakens demand further. Once the economy picks up and we hit full employment, the government can pay back its debt. If that extra spending causes too much inflation, the government can just raise taxes to pull excess money out of circulation.
Deficit Spending and the Multiplier Effect
Keynes also pointed out a bonus to government spending: the multiplier effect. This means that every dollar the government spends can lead to more than a dollar in total economic output. It works because that dollar gets spent again and again as it passes through the economy.
Criticism of Deficit Spending
While many accept this approach, deficit spending has its critics, especially from the conservative Chicago School of Economics, who see it as unnecessary government meddling. They argue it won't boost consumer or investor confidence because people know it's temporary and will lead to higher taxes or interest rates later.
This criticism goes back to 19th-century economist David Ricardo, who said people anticipate the need to repay deficits through taxes, so they save instead of spend, robbing the economy of the intended stimulus. Some economists also warn that unchecked deficit spending could harm growth by forcing tax hikes or even debt defaults. Plus, selling government bonds might crowd out private borrowers, messing with prices and interest rates in the markets.
Modern Monetary Theory
There's a newer perspective called Modern Monetary Theory (MMT) that's picking up steam, especially on the left, and it defends Keynesian deficit spending. MMT proponents say that for a country with its own currency, as long as inflation stays in check, there's no need to fret over too much debt from deficits— the government can always print more money to cover it.
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