Economic Growth and Government

Deficit Spending

What is deficit spending and how does it work

Deficit spending takes place when the government expenditures surpass the government revenues in a fiscal period, which in turn increases government debt balance. This surplus spending has to be financed through borrowing, more often from global financing establishments and foreign governments. On one hand, the augmented government spending can facilitate stimulate the economy taking into account more money flows in. On the other hand, this can be detrimental as increased government borrowing can lead to higher rates of interest. This implies that deficit spending is causal to both, benefits as well as disadvantages (Investopedia, 2016).

Advantages

There are benefits to. One of the advantages of deficit spending is in its deployment for mitigating financial crisis through measures taken to increase economic growth. The government is able to spend the funds on infrastructure, increase public goods and also generate more employment opportunities for the workforce. Having such economic developments within the nation, this becomes more appealing to investors. This means that if a government builds roads, railways and other infrastructure such as bridges, then this is beneficial as it increases consumption (Green Garage, 2015). In turn, this leads to greater number of job prospects and increase in the economic growth rate. A second advantage of deficit spending is that it provides control. Deficit spending gives rise to a budget deficit. In turn, when a nation is going through a budget deficit, then government establishments take a great deal of consideration prior to making needless investments. In addition, the interest rates of the funds given play an important role in planning, as greater amounts of interest force governments to innovate and devise judicious plans to reimburse the debt amounts as fast as possible (Green Garage, 2015).

Disadvantages

Deficit spending does have its disadvantages. One of the key shortcomings is that it leads to a decrease in investments. When a government's deficit spending continues to increase, the level of debt will largely amplify leading to further recession. The inference of this is that the government will have fewer funds to spend on infrastructure and will dissuade investors from undertaking business in the nation. Secondly, deficit spending can lead to a bad economy. In the course of a deficit period, a nation characteristically has no savings taking into account the fact that they have to place priority on paying off the debt amount and its interest. This means that in times of further crisis, the nation may not have funds and will be forced to further borrow from other countries or other financial establishments such as World Bank. In turn, this gives rise to a vicious cycle (Mitchell, 2005). Another detrimental impact is the inclination of the government administration to increase the taxes, decrease public services and augment prices of goods, which ultimately gives rise to inflation and a lower standard of living. Another downside of deficit spending is that it can risk national sovereignty. The countries and international financing establishments that provide funds to a nation in recession can make influence local conditions and enforce demands prior to approving loans. For instance, the government may be forced to alter its laws and policies on spending. What is more, this might force the nation to put up for sale land and other assets to service its debt (Green Garage, 2015).

Crowding-out Effect

Crowding out effect takes into account a circumstance when higher rates of interest give rise to a decline in private investment spending in the sense that it hampers the initial increase in overall investment spending. In particular, governments have the power and authority to borrow huge amounts of money, which in turn can have a significant impact on the real rate of interest, increasing it substantially. This has the influence of gripping the lending capability of the economy and of dissuading companies and businesses from participating in capital projects. Considering that privately held companies finance these sorts of projects partly or wholly, they become disheartened owing to the fact that the opportunity cost of borrowing funds has increased, causing customarily profitable project financed via loans to be cost exorbitant (Investopedia, 2016).

Conclusions: Do you believe that deficit spending helps or hinders short-term and long-term economic growth?