Question

What effects do "governments preferring to use transfer payments for deflationary deficit compared to to spending" create?

Answer 1

In a deflationary deficit, the growth of economy is very slow and the prices fall below the acceptable level as a response to the fall in demands. This has vast repercussions like mass layoffs, business units shutting down and getting bankrupt. In order to survive this 'recession', households and businesses hold on to more money due to the pessimistic turn around by the economy.

Now, let's look into what exactly is transfer payments? This is a payment done by the government with no goods or services expected in return. Examples of this include unemployment insurance and paycheck during the current pandemic. By transfer payments, the government tries to stimulate the consumption of these households as there is extra liquid at their disposal. So, is the problem of deflationary deficit solved? Certainly not.

Well, how long can the government ensure transfer payments for the entire population. This will be huge burden on the government and the budget deficit will skyrocket. Once the unemployment surges steadily, the burden on the government increases too, and they are not even a position to generate more tax income due to the current situation. Lot of people have mortgage payments which are being defaulted at a higher rate. The government cannot certainly cover for these, and this means that the financial institutions are at a loss forcing the economy to a deflationary spiral despite spending money on transfer payments. Therefore as a best alternative, government spending is considered.

Because of government spending, infrastructure is developed thereby encouraging the business units to reopen and new businesses to use this opportunity to establish themselves. When businesses open up, the demand for labor increases, meaning unemployment decreases and the government's budget on unemployment insurance is saved to a great extent. This slowly elevates and stimulates the economy, spreading optimism with the households. Because of the economic stimulation, individuals have more savings at their disposal and therefore consumption increases. And thereby, within a short span of time the economy comes out of deflation. Usually this is the alternative plan by the governments to stimulate the economy and keep it stable in the long run. For short periods of economic downturn like the case of CoronaVirus, transfer payments may be useful, but again not on the long run.

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