Deficit Spending

ECON102

American Public University

Professor

1 February 2012

Deficit Spending

Simply put, deficit spending is when the government spending exceeds revenue. With government spending plus money transfers (such as welfare, SSI, and unemployment) plus debt payoffs you get what is called the budget. The budget is then subracted from the tax revenues to reveal either a surplus in revenue or a deficit in revenue (Fitzgerald, 2010). Although deficits sound like bad news, the deficits can be very benificial to the economy for a few reasons.

When the GDP is increased, unemployment rates go down and prices stay relatively unchanged. More jobs are being produced because more goods are being produced. When there is a lower rate of unemployment, more income is being made and spent back into the economy which in turn, creates a greater GDP. The maximum level for spending is when there is full employment. Full employment doesn't mean that everyone in the nation is employed, it simply means that everyone who could possibly work or have a job most likely does; this excludes people who are still in the process of looking for a job, students, and retired people. The supply curve now becomes a vertical line because the output produced has reached its maximum production. This is where surplus comes in. Everyone has a job, (that could possibly have a job) and the maximum output for products has been achieved; so now the prices begin to rise in order to create less of a demand. The curve in between deficit and surplus on the graph represents the modified aggregate supply curve (Strickland, 2012).

There are a few advantages of having deficit within the economy. First, capital expenditures such as education programs, new construction, highway systems benefit the economy in the long run. Though in the future, taxes will be increased to pay back the deficits, but depending on the capital investment, it could, in the long run, benefit everyone's income (Danby, 1998). Also, according to Danby, the use of countercyclical policy "can help reduce the severity of a recession." (1998). Countercyclical policy simply refers to the government either spending more money or lowering taxes which would in turn lower the aggregate demand.

The main disadvantage to having government deficit is the fact that it does nothing but add debt to the bill. Deficit is the amount borrowed for the current year. Then after the year passes, it cycles into the debt. For over 30 years, deficit has been adding to the pile of debt this government owes (Danby, 1998). This causes higher interest rates for the public to, in a sense, pay the government's bills. Another disadvantage is the term called "crowding out".

The "crowding out" effect