Deficit Spending in Economy | Free Essay Example

Deficit Spending in Economy

Words: 707
Topic: Business & Economics


Deficit spending affects the economy and labor market in various ways. A deficit occurs when the level of government’s revenue is below its spending. Apart from deficit spending, the government may decide to use surplus. In surplus spending, the expenditure is below revenue. Increase in spending may come in through a number of ways. For example, the government can reduce the tax or employ more individuals, especially the military and civilians. In this form of spending, more people will be paid money in order to work for the government. More money will be spent on employment. The government also spend extra cash on transfers. Examples of transfers are in-kind subsidies, food stamps, and insurance on unemployment (Holahan & McMorrow, 2012).


Deficit spending is beneficial to the country in the following ways:

  1. It increases the employment level, especially when the government employees additional civilians and military personnel.
  2. The spending will make the citizens have more disposable income. Reduction in tax level by the government cushions people from increased deductions. People will have more income when the tax rate is reduced.
  3. The interest rate is low during deficit spending. The interest rate is low because supply in saving is at its peak. This means more money is available for investment. The banks will lower their interest rate in order to make citizens take loans (Corsetti & Müller, 2012).
  4. Deficit spending increases expenditure in the private sector. The private sectors will increase their spending due to availability of cheap loans. The loans are not expensive because the interest rate is low.
  5. Deficit spending decreases the cost of funds. The cost of funds is determined by the interest rates. Low interest rate lowers cost of funds, while high interest rate increases the cost of funds.
  6. Labor productivity is at its peak during deficit spending. Investment in health and teaching sector increases workforce the sectors.


Anything that has advantage must have disadvantage. The disadvantages of deficit spending are:

  1. The government operates a deficit budget, where the amount of money that comes in is less than the amount of money being spent. This means that the government is not saving any cash and investment level is minimum.
  2. Tax reduction is beneficial to the citizens but injurious to the government. Total amount of contribution from taxes is low (Corsetti & Müller, 2012).
  3. Deficit spending increases debt level of the federal government. The state is forced to borrow money in order to increase it spending. The excess money spent by the government may come from other foreign countries.
  4. Unemployment insurance and subsidies on low-income earners is not good because it reduces the effort of people when it comes to working.

Crowding-out effect

Crowding out effect refers to a situation where the federal government increases its borrowing. Private sector spending is replaced due to increased level of spending in the public sector. The government funds its operations through increasing the level of deficit spending or taxes. The money that the government borrows is used to finance its projects. The interest rate goes up due to increased government borrowing.

The government borrowing reduces supply of money that was available for investment due to saving. Demand of money goes up, but its supply remains the same (Holahan & McMorrow, 2012). Increased demand of money makes the interest rate to rise. The loans become too expensive that only the government can borrow. Small companies and individuals are forced to look for another alternative due to the high cost of loans. Crowding out effect slows down economic growth because of the reduction in private sector spending.


In order to get deficit spending, the difference between government spending and its revenue must be calculated. Many researchers argue that deficit spending has a negative effect on long-term economic growth. Since the government is spending more than what it is collecting, the saving goes down. Lack of saving means the government is not able to invest. Economy will not grow if the government is not investing. Deficit spending affects short-term economic growth positively. The private sector can invest heavily due to availability of loans at a lower cost. During this time, the unemployment level will go down, and income level of citizens will increase due to low taxation rate.


Corsetti, G., & Müller, G. J. (2012). What determines government spending multipliers?. Economic Policy, 27(72), 521-565.

Holahan, J., & McMorrow, S. (2012). Medicare and Medicaid spending trends and the deficit debate. New England Journal of Medicine, 367(5), 393-395.