Sample Economics Essays on Deficit Spending

Introduction

The government plays a critical role in stabilizing and improving the economy of its country. Numerous means of achieving at a stable economy exist, and the choice of the method to use lies upon the government. While the means that the government chooses are meant to stabilize the economic progress and improve the economy, some actions can cause an economic crisis. One such occurrence is deficit spending. Deficit spending is whereby the government’s expenditure is more than the revenue it receives through taxation; the excess being borrowed funds. Although deficit spending is not often good for the government, most economists agree that deficit spending is sometimes necessary. Economists from the Keynesian school of thought argue that through deficit spending, the government can achieve full employment and a high rate of economic growth. This is because during the boom phase of the business cycle, tax revenues increase. Contrarily, during the recession phase, tax revenues fall. Notably, government expenditures such as unemployment compensation fall during the boom phase. However, such expenditures increase during a recession. Therefore, when deficit spending is controlled, it can moderate or end a recession resulting in a balanced economy. This essay will discuss the advantages and disadvantages of deficit spending, as well as the effect of government borrowing on the economy.

Advantages of Deficit Spending

It may seem irrational for a government to borrow debts without any foreseeable means of paying them back. However, although deficit spending increases the government debt, it may prove more beneficial for the country to borrow debts instead of raising taxes to finance an economy. This can be portrayed during the recession period when a country’s aggregate income falls leading to high unemployment levels. As a result, the government is forced to seek economic assistance to sustain its operations. If the government decides to increase taxes to raise funds for the increased cost of government subsidy programs, it would further deteriorate the economy because the already poor citizens would struggle to raise the increased federal taxes. However, if the government borrowed debts, it would be able to generate a greater output within the economy, which, in turn, would raise the employment levels and reduce subsidy programs’ spending hence end the recession phase. Therefore, deficit spending would be beneficial to the economy in this case.

Another way in which deficit spending is beneficial to an economy is the growth that results from the borrowed funds. When a government operates within a deficit, it can afford to put up the infrastructure for the country which increases employment levels, encourages productivity, and results in economic growth. Also, during the recession period, the inflow of foreign borrowings can encourage investment ventures and encourage business activities. These would lead to overall economic development and growth of a country (Miller & Benjamin, 2012). Moreover, deficit spending increases the government’s prudence over economic decisions. When a government operates on a deficit, it makes careful economic decisions and avoids unnecessary spending and investments which greatly contributes to economic prosperity.

Disadvantages of Deficit Spending

Although reasonable benefits are associated with deficit spending, it also presents disadvantageous effects on the economy. As deficit spending increases, so does the overall cost that must be incurred to settle the national debt. This leads to an increase in taxes to pay off the debt which leads to inflations since the cost of both essential and non-essential goods is raised. Consequently, the standards of living are lowered. The inflation occurs because when unemployment rate is high, there is low income and so demand for goods decreases. Therefore, cost of production increases and the same is reflected in prices so as to compensate for the low demand of goods.

Another disadvantage of deficit spending occurs when the lenders are reluctant to invest in an individual or organization because of the unpredictability of the market. This may render the borrower unable to offset their debt. While the government may use deficit spending seeking to invest and boost the productivity of an economy, there is no assurance that the economy will change for the better. Therefore, while the debt will remain, the investments in the country remain constant. This uncertainty prompts the lenders to raise the interest rates to unusual levels making payments higher, and in some cases, unpayable. Consequently, they may end up deflating the country’s economy further.

Crowding out Effect

One of the worst limitations of deficit spending can be evident in the ‘crowding out’ effect. The effect occurs when the government subsidizes the economy too much eliminating private-sector spending. For instance, the government’s decision to provide free education for the poor citizens may sound admirable but when the financially stable begin to utilize the free education services to save their money then a crisis occurs (Zhang, 2011). This crowds out the private sector’s educational programs since demand for their more expensive education will decline. Ultimately, the economy plummets due to an unstable workforce.

Although deficit spending poses various advantages, it should not be the go-to strategy for funding a country’s economy because it slows down both the short and long-term economic progress. Foreign borrowing increases debt, and ultimately, this affects the rate of taxation and causes inflation. All these implications are detrimental to an economy.

References

Miller, R., & Benjamin, D. (2012). The economics of macro issues. New York: Addison-Wesley.

Zhang, Y. (2011). Crowding-out effect of the current food stamp subsidy scheme. Economics Letters, 112(1), 1-2. doi: 10.1016/j.econlet.2011.02.028