Question

Explain if budget deficits are a good thing or a bad thing as a national strategy.

Answer 1

The first thing to remember is that deficits are not always bad.. If the economy enters recession, deficit spending by tax cuts or government purchases of goods and services will interrupt the downward trend and help turn the economy around. Deficits will also help us stabilize the economy. However, when the economy is improving due to the deficit spending, the outlook for businesses is also rising, and this may lead to increased investment, an impact known when crowding in.

Deficits often encourage us to purchase services and spread costs over time similar to how households fund a car or house buying, or how local governments fund schools with bond issues. This helps us to purchase services that we would not be able to afford if it had to be funded all at once (this may also require future generations to share the building costs to benefit from the expenditure). Lastly, deficits can be used to fund wars, but whether that is a good or a bad depends on whether the war is right.

The biggest issue about deficits is being squeezed out. Crowding in has only been identified as occurring when deficits cause the production to rise and business confidence to grow. When deficit spending increases interest rates, crowding-out comes in. There is a finite amount of funds available for investment, and as government competes with the private sector to finance the deficit spending for a share of those funds, it increases the cost of such funds because "interest rates are higher.

The increase in interest rates leads to a decline in investment, and lower investment results in lower production and lower economic growth. Furthermore, to the degree that the private sector is more effective than the public sector, crowding out, i.e. more government spending and less private expenditure, can result in less resource efficient usage (although government may be the more productive provider in the case of public goods, and therefore it is not always the case that efficiency falls).