Deficit Spending “Spending financed not by current tax receipts, but by borrowing or drawing upon past tax reserves.” , Is it a good idea? Why does the U.S. run a deficit? Since 1980 the deficit has grown enormously. Some say its a bad thing, and predict impending doom, others say it is a safe and stable necessity to maintain a healthy economy. When the U.S. government came into existence and for about a 150 years thereafter the government managed to keep a balanced budget. The only times a budget deficit existed during these first 150 years were in times of war or other catastrophic events. The Government, for instance, generated deficits during the War of 1812, the recession of 1837, the Civil War, the depression of the 1890s, and World War I. However, as soon as the war ended the deficit would be eliminated and the economy which was much larger than the amounted debt would quickly absorb it.
The last time the budget ran a surplus was in 1969 during Nixon’s presidency. Budget deficits have grown larger and more frequent in the last half-century. In the 1980s they soared to record levels. The Government cut income tax rates, greatly increased defense spending, and didn’t cut domestic spending enough to make up the difference. Also, the deep recession of the early 1980s reduced revenues, raising the deficit and forcing the Government to spend much more on paying interest for the national debt at a time when interest rates were high.
As a result, the national debt grew in size after 1980. It grew from $709 billion to $3.6 trillion in 1990, only one decade later.
Federal spending has grown over the years, especially starting in the 1930s in actual dollars and in proportion to the economy (Gross Domestic Product, or GDP). Beginning with the “New Deal” in the 1930s, the Federal Government came to play a much larger role in American life. President Franklin D. Roosevelt sought to use the full powers of his office to end the Great Depression. He and Congress greatly expanded Federal programs. Federal spending, which totaled less than $4 billion in 1931, went up to nearly $7 billion in 1934 and to over $8 billion in 1936. Then, U.S. entry into World War II sent annual Federal spending soaring to over $91 billion by 1944. Thus began the ever increasing debt of the United States. What if the debt is not increasing as fast as we think it is? The dollar amount of the debt may increase but often times so does the amount of money or GDP to pay for the debt. This brings up the idea that the deficit could be run without cost. How could a deficit increase productivity without any cost? The idea of having a balanced budget is challenged by the ideas of Keynesian Economics.
Keynesian economics is an economic model that predicts in times of low demand and high unemployment a deficit will not cost anything. Instead a deficit would allow more people to work, increasing productivity. A deficit does this because it is invested into the economy by government. For example if the government spends deficit money on new highways, trucking will benefit and more jobs will be produced. When an economic system is in recession all of its resources are not being used. For example if the government did not build highways we could not ship goods and there would be less demand for them. The supply remains low even though we have the ability to produce more because we cannot ship them. This non-productivity comes at a cost to the whole economic system. If deficit spending eliminates non-productivity then its direct monetary cost will be offset if not surpassed by increased productivity.
For example in the 1980’s when the huge deficits were adding up the actual additions to the public capital or increased productivity were often as big, or bigger than the deficit. This means as long as the government spends the money it gains from a deficit on assets that increase its wealth and productivity, the debt actually benefits the economy. But, what if the government spends money on programs that do not increase its assets or productivity. For instance consider small businesses. If the company invests money to higher a new salesman then he will probably increase sales and the company will regain what it spent hiring him. If the company spends money on a paper clips when they have staplers they will just lose the money spent on the paper clips. This frivolous spending is what makes a deficit dangerous. Then the governments net worth decreases putting it into serious debt. Debt should not be a problem because we can just borrow more, right? This statement would be correct if our ability to borrow was unlimited, but it is not. At first the government borrowed internally from private sectors.
The government did this by selling bonds to the private sectors essentially reallocating its own countries funds to spend on its country. This works fine in a recession, but when the country is at or near its full capability for production it cannot increase supply through investment of deficit dollars. Deficit dollars then translate into demand for goods that aren’t being produced. Referring back to the small business example, if a company is selling all the products it can produce they can still higher another salesman. But since there are no more goods to be sold the salesman only increases the number of consumers demanding the product. Without actually increasing sales. The problems of deficit spending out of a recession even out through two negative possibilities, inflation and crowding out.
Inflation means there is more demand or money than there are goods this causes an increase in prices and drives down the worth of the dollar. This depreciation of the dollar counters the cost of the deficit but destroys the purchasing power of the dollar. A five dollar debt is still a five dollar debt even if the five dollars are only worth what used to be a five cent piece of bubblegum. Despite its dangers inflation is used to some extent to curb the debt. Crowding out is when the government is looking for the same capital that the business sector wants to invest. This causes fierce competition for funds to invest. The fierce competition causes an increase in interest rates and often business will decide against further investment and growth. The government may have the money to build new highways but the truckers cannot afford trucks to use on them. The governments needs will “crowd out” business needs. This turns potential assets into waste.
However, there is a third option which would allow the government to run a deficit and avoid the negative aspects of inflation and crowding out. Borrowing from foreign sources is a tangible and recently very common practice. Attracted by high interest rates and stability, foreigners now buy huge amounts of U.S. national debt. Of course this cannot be the perfect solution otherwise no one would be concerned about the debt. The problem with borrowing from external sources is the lack of control the government has over foreign currency and debts. Internal debts can be paid with increased taxes, inflation, and other monetary controls the government has but external debts can extremely damaging to a country if it cannot buy enough of the foreign currency to pay the interest.
Running a deficit is apparently good for an economy that is operating inside its production possibilities curve but it can be damaging to an economy operating on the curve. A deficit managed properly has the effect of increasing demands. An economy inside its curve can increase supplies in reaction. An economy on the curve can increase demand but its supplies cannot increase causing prices to rise, or inflation. If there is no deficit and the curve shifts to the right then supplies will not increase and the country will no longer be operating on the curve. A deficit must be maintained to insure that the economy grows with its resources. Is the U.S.’s current debt bad or good? The trick is finding out how large the deficit should be in order to allow for growth without waste.
The U.S.’s deficit is bad at this point because the U.S. is close to its maximum production capabilities, and deficit money is being wasted. For example two of the largest portions of the budget: defense and social security. Defense spending produces little or nothing except in times of war. Judging by the current status of the United States as the only existing “Nuclear Super Power” war is not a tangible event in the near or distant future. The way social security is managed creates a huge waste. As managed, social security is money spent to immobilize a large and fairly capable part of the work force. It encourages elderly people not to work by spending deficit money on them. Reducing productivity and increasing the debt at the same time. In its current state the U.S. should attempt to reduce its deficit but eliminating it is not necessary and could do more damage than good.
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