What is 'Deficit Spending '

Deficit spending occurs whenever a government's expenditures exceed its revenues over a fiscal period, creating or enlarging a government debt balance. Traditionally, government deficits are financed through the sale of public securities, particularly government bonds. Many economists, especially in the Keynesian tradition, believe government deficits can be used as a tool of stimulative fiscal policy.

BREAKING DOWN 'Deficit Spending '

Deficit spending is an accounting phenomenon. It is only possible to engage in deficit spending when revenues fall short of expenditures. However, nearly all of the academic and political debate surrounding deficit spending focuses on economic theory, not accounting.

Deficit Spending as Fiscal Policy

According to demand-side economic theory, a government can begin deficit spending after the economy falls into recession. The famed British economist John Maynard Keynes is often credited with the concept of deficit spending as fiscal policy, though most of his ideas were re-interpretations or modifications of older mercantilist arguments.

In fact, many of Keynes’ spending ideas were tried before “The General Theory” was published in 1936. Herbert Hoover, for example, fought the Great Depression by increasing federal government spending more than 50% and engaging in massive public works projects during his four years in office between 1928 and 1932.

What Keynes managed in 1936 was to give academic and intellectual legitimacy to deficit spending programs. He argued a drop in consumer spending during the recession could be met by a corresponding increase in government deficit spending, maintaining the correct level of aggregate demand to prevent high levels of unemployment. Once full employment was achieved, Keynes believed, the market could return to a more laissez-faire approach and the debt could be repaid. If the extra government spending were to cause inflation, Keynes believed the government could simply raise taxes and drain extra money out of the economy.

Deficit Spending and Economic Growth

Deficit spending is often misinterpreted as a pro-growth policy tool. This may be because deficit spending is positively correlated with gross domestic product (GDP). However, since one of the key components of the GDP equation is government spending, it is tautological and not empirical that the two tend to rise and fall together.

As Keynes articulated, the main role of deficit spending is to prevent or reverse rising unemployment during a recession. Keynes did believe there could arise a secondary benefit of government spending, something often called “the multiplier effect.” According to the theory, a single dollar of government spending might increase total economic output by more than $1.

There are plenty of theoretical and empirical challenges to the notion of the Keynesian multiplier. A huge series of econometric tests have been run, with various and inconclusive results.

If left unchecked, some economists argue, the effects of deficit spending pose a threat to economic growth. Too large a debt, wrought by consistent deficits, might force government to raise taxes, pursue inflationary monetary policies, or default on their debt obligations. Additionally, the sale of government bonds crowds out private issuers and might distort prices and interest rates in capital markets.

RELATED TERMS
  1. Deficit

    The amount by which a resource falls short of a mark, most often ...
  2. Budget Deficit

    A status of financial health in which expenditures exceed revenue. ...
  3. Economic Stimulus

    Attempts by governments or government agencies to financially ...
  4. John Maynard Keynes

    An author and economist who is well-known for his stance that ...
  5. Fiscal Policy

    Government spending policies that influence macroeconomic conditions. ...
  6. Fiscal Deficit

    When a government's total expenditures exceed the revenue that ...
Related Articles
  1. Trading

    Breaking Down The U.S. Budget Deficit

    Find out why this particular piece of national financing gets so much attention from the media and investors.
  2. Insights

    Twin Deficits: Twice The Fun For The U.S

    The U.S. has been running both fiscal and current account deficits for years, but what does it all add up to?
  3. Investing

    Fiscal Deficit

    A shortfall that occurs when government spending exceeds government revenues, or taxes.
  4. Insights

    What's a Deficit?

    A deficit is the amount by which expenses or costs exceed income or revenues.
  5. Small Business

    How Budget Deficits Work

    How do governmental and business budget deficits function?
  6. Insights

    The Current State of the U.S. Debt

    Discover the current state of U.S. national debt, whether it's increasing or decreasing, and what is projected for the next 10 years.
  7. Insights

    Can Keynesian Economics Reduce Boom-Bust Cycles?

    Learn about a British economist's proposed solution to a common economic problem.
  8. Insights

    The Pros & Cons of a Trade Deficit

    Is a trade deficit, also known as a current account deficit, beneficial or detrimental to a country's economy?
  9. Personal Finance

    Current Account Deficits: Government Investment Or Irresponsibility?

    Deficit can be a sign of trouble for some countries, and of health for others. Find out what it means when more funds are exiting than entering a nation.
  10. Insights

    Economist Guide: 5 Lessons John Maynard Keynes Teaches Us

    Read about the paradoxical and confusing world of John Maynard Keynes, including the lessons modern economists can still learn from the British thinker.
RELATED FAQS
  1. What is the role of deficit spending in fiscal policy?

    Read about the role deficit spending can play in a government's fiscal policy, and learn why economists are torn about the ... Read Answer >>
  2. Who thinks fiscal deficits are a good idea?

    Find out why nearly all political actors support the concept of governments incurring fiscal deficits, either explicitly ... Read Answer >>
  3. What is the effect of a fiscal deficit on the economy?

    Take a deeper look into the real impacts of government budget deficits on the economy, and why government financing reduces ... Read Answer >>
  4. Is there any limit on fiscal deficits at the federal level?

    Discover the legal, theoretical, practical and political limitations imposed on the fiscal deficits accumulated by the U.S. ... Read Answer >>
  5. How long has the U.S. run fiscal deficits?

    Read about the history of deficit spending in the United States, dating back to 1789, and learn about then-Treasury of the ... Read Answer >>
  6. What is the difference between fiscal deficit and federal debt, and which is worse?

    Read about the primary differences between the federal government's fiscal deficits and its total debt, and find out which ... Read Answer >>
Hot Definitions
  1. Federal Direct Loan Program

    A program that provides low-interest loans to postsecondary students and their parents. The William D. Ford Federal Direct ...
  2. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  3. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  4. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  5. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  6. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
Trading Center