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Research Papers on Deficit Spending

Deficit spending refers to any spending that exceeds revenue, and can refer to spending by a government, corporation, or individual. The person or organization simply spends more money that it brings in. It is mostly used to describe government spending, and remains a controversial economic issue.

Most mainstream economists hold that deficit spending is a desirable and necessary function of government, but that government should restrain from keeping a structural (permanent) deficit. During recessions, it is argued, governments should initiate deficit spending in order to stimulate growth, and run surpluses during boom periods in order to offset debt. This was the viewpoint put forth by John Maynard Keynes.

The basis of Deficit Spending Research

Fiscal conservatives reject Keynesian economics and argue that a government should always maintain a balance budget and pay down debt. This viewpoint is codified among the various states, as all but Vermont have balanced-budget amendments in their state constitutions. Adam Smith argued that households should never run deficits, but some economists claim that this should not apply to governments.

Many Post-Keynesian economists prefer to argue that deficit spending is necessary in order to expand the economy. If the economy grows, so should the monetary supply. Most governments issue bonds in order to fund their deficit spending. During recessions, deficit spending generally increases as governments attempt to counter the downturn.Deficit Spending

Arguments Against Deficit Spending

Arguments against budget deficits hold their own substantial weight, especially in light of the current Asian crisis. During the Reagan years the deficits caused by huge tax cuts and enormous growth in military spending should have overheated the economy, causing prices to soar. But inflation did not get out of hand. In fact, it fell. No one has a complete solution to this mystery, but part of the answer lies in the massive infusion of capital from overseas. Foreigners found ideal investment opportunities in the United States: they received high rates of return on their money, and political and social stability made them feel their assets were safe. Generous interest rates and stability have therefore attracted billions of dollars in foreign investments. This influx of funds has, in effect, helped pay for the deficit and compensate for the shortfall in investment and savings.

Looking long-term, this dependence may turn out to be a time bomb, for the following reasons:

  1. Large-scale foreign investments inevitably mean that a sizable share of our income has to go abroad for interest payments. (This undercuts the argument made above about the government owing only to Americans.)
  2. When Japanese, German, and other investors slow down or stop the transfer of capital, America is in for a rough landing:
    1. America will be confronted with sharply climbing prices and interest rates and a declining standard of living.
    2. America will also have to find ways to increase savings and investments, and that means keeping the budget deficit down. But a reduced deficit can be achieved only by painful tax increases or cuts in popular programs or both.

Also, there are a number of factors which are directly affected by the size of government expenditures, particularly if they are in excess of government revenues. 

Long-term interest rates are one of the most important factors, particularly in the realm of the percentage of expenditures which are ultimately devoted to paying the interest on the national debt.  These rates are generally accepted to be affected by the expenditure side, however the relationship is not without its detractors.  First, "high nominal and real intermediate- and long-term interest rates" might remain in the presence of deficits, but while the Federal Reserve can change short-term rates through various monetary instruments, it is not necessarily the case that long-term rates would be reduced following any deficit reduction obtained through short-term rate cuts.

Federal spending increases demand overall, in part through the employees it hires, and through the procurement that it does from the private sector, thereby increasing overall purchasing power, whereas taxation reduces purchasing power.  This employment theory was an accepted microeconomic theory before Keynes.  However, Keynes long believed that when government spending is equal to the amount of money taken in through taxes, the government does not have any effect on budget deficits; and, further, when recessionary conditions of decreasing tax revenues, increasing unemployment compensation, and increasing social program expenditures are not present, the budget deficit would in fact stimulate aggregate demand.

Unlike many economists whose individual ideas appeared in The General Theory, Keynes was able to bring about a revolution by getting these ideas accepted by economists everywhere. The General Theory presents a shift in emphasis from microeconomics to what can be referred to as macroeconomics (which deals with aggregates and effects on the total community); from a concentration on the long run to the short run; and most significantly, from an emphasis on production and allocation of resources to the problem of employment. If unemployment was ever examined at all, it was not studied as a variable, but instead was viewed as a fixed factor. Because of the belief that underemployment equilibrium was an impossibility, economists had avoided the problem of unemployment. Full employment, Keynes concluded, could be maintained in a capitalist economy but only if the government was willing to incur counter-cyclical budgetary deficits to offset the natural tendency towards private over-saving. These ideas have become the most influential in our time. The economic ideas of America were shaped by the ideas he brought forth in his greatest economic works and theories.

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