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Understanding the Concept of Deficit Spending with Examples

Understanding the Concept of Deficit Spending with Examples

Deficit spending occurs when the expenses incurred are more than the receipts. It is usually associated with the government's policies regarding spending of economic resources. This Buzzle article will help you understand the concept of deficit spending and its historical significance along with some examples.
Neha B Deshpande
"I don't think we'll solve the problem of the deficit until three things happen: We need more discipline on spending in Congress. We need a constitutional amendment requiring Congress to balance the budget. And we need to give our presidents a line-item veto."
―Ronald Reagan, An American Life
Deficit spending occurs when the expenses incurred are more than the income during a particular period. This terminology is commonly associated with government spending and its fiscal policies. However, it has been chronicled by arguments, with criticism by many economists on one hand, while others say that it is necessary during times of need, and is advantageous to the economy. There are many reasons why deficit spending can occur.

Let's delve deeper into how deficit spending occurs, the reasons, sources of borrowing, and its impact on the economy.

When Does Deficit Spending Occur?

► Here's a quick recap of the concept of deficit spending. It occurs when the government spends more than its receipts. It may occur due to several reasons such as war, natural calamities, emergency situations such as epidemics, etc., or any unknown situation which may arise, that may induce the government to increase their spending during a certain period. However, you can apply the concept of deficit spending to a simple real-life example too.

► Say you plan to buy a vehicle for your family, and your income is not sufficient to bear the cost of the vehicle. However, buying a vehicle has become a necessity. In that case, you borrow funds from institutional or non-institutional sources and buy the vehicle out of borrowed funds. This is nothing but deficit spending. Similarly, the government faces a situation of deficit spending in case there is a need to spend more than the collections. Of course the scenario of government spending is more complicated, and this kind of spending has to be approved by the requisite authorities.

► In a similar scenario, a corporate entity may have a situation of deficit spending in case it needs funds for capital investment i.e. to buy a new asset or to initiate a new project. In that case, the company borrows funds either through debt or through equity.

Viewpoint of Economist John Maynard Keynes

► Keynes was a modern economist who supported deficit spending, saying that the need to spend was due to the fact that it may be a catalyst to the growth of an economy. The government may borrow from the private sector and repay them by spending on infrastructure and other growth plans.

► He stated that such a kind of government spending should be done in certain limits, beyond which, it may prove to be a disadvantage to the economy, and may even result in inflation.

Sources of Debt Funds for the Government

► While the primary source of revenue for any government is taxes - in the form of income tax, excise tax, customs and other miscellaneous receipts, the government has to spend on medical facilities, social security, defense, infrastructure, etc. Whenever, the spending is more than the revenue collected for that fiscal year, it results into deficit spending.

► The U.S. Government borrows from the public in the form of treasury bonds and securities. These securities can be bought by private individuals, entities or banks. In return, the lenders are paid an interest when their securities are redeemed. Many investors who prefer investing in low-risk securities prefer government securities over stocks traded by companies.

Impact of the Great Depression

► The Great Depression that started around the 1930s had a huge impact on the fiscal policies of the American economy. The stock market crashed, there was huge growth in unemployment, and the production levels were hugely affected, highlighting one of the blackest times in the history of the American economy.

► When President Franklin D. Roosevelt took over, he followed the Keynesian theory and increased deficit spending though conservative economists were against these policies. To hike the purchasing power of the economy, funds were spent on creating employment opportunities, pension, military expenses, etc. This established deficit spending as an accepted method to fight depression. However, many were still wary about the overuse of deficit spending.

Impact of the Great Recession

► Recession impacts the budget deficits of the government in many ways. It affects employment opportunities, which in turn reduces the tax revenue of the government. On the other hand, to boost the economy, the government has to pump more revenue in the market, by spending more on the schemes and programs concentrated on helping the masses for their economic distress. Moreover, this obviously increases budget deficit. A glaring example of this was 'The Great Recession' that started around 2007 and added to the mound of deficits.

Difference between Debt and Deficit

► Deficit represents the excess of spending of the government over its collections in a particular fiscal year. Whereas, a debt represents the amount borrowed by the government by issuing bills, notes, bonds, and securities in the market to fund the deficit spending.

Reagan's Economics

► Commonly referred to as Reaganomics, it refers to the economic decisions taken by President Ronald Reagan during the 1980s. His strategy involved reducing the taxes, government regulation, and excessive spending. During his tenure, many job opportunities were created and his strategy of tax cuts benefited the citizens. However, during his tenure, the budget deficits had also increased.

Recent News

Recently, the U.S. Treasury has reported that the budget deficit for the fiscal year 2014 is approximately around USD 483 billion, which is its lowest since 2007.

While deficit spending is a common phenomenon, there are two schools of thought regarding whether it is good or bad. This topic is always a subject of controversy and also a subject of fancy for many journalists and economists. There has been a lot written about the policies regarding deficit spending. Apparently, it seems deficit spending is good in the short run. However, experts believe that it may have negative side effects. Economists claim that attempts should be made to curb the overuse of this method and have a fair method to adopt.