Essay/Term paper: Deficit spending: the deficit good or bad

Essay, term paper, research paper:  Economics

Deficit Spending: The Deficit Good or Bad


"Spending financed not by current tax receipts, but by borrowing or
drawing upon past tax reserves." , Is it a good idea? Why does the U.S. run a
deficit? Since 1980 the deficit has grown enormously. Some say its a bad thing,
and predict impending doom, others say it is a safe and stable necessity to
maintain a healthy economy.
When the U.S. government came into existence and for about a 150 years
thereafter the government managed to keep a balanced budget. The only times a
budget deficit existed during these first 150 years were in times of war or
other catastrophic events. The Government, for instance, generated deficits
during the War of 1812, the recession of 1837, the Civil War, the depression of
the 1890s, and World War I. However, as soon as the war ended the deficit
would be eliminated and the economy which was much larger than the amounted debt
would quickly absorb it. The last time the budget ran a surplus was in 1969
during Nixon's presidency. Budget deficits have grown larger and more frequent
in the last half-century. In the 1980s they soared to record levels. The
Government cut income tax rates, greatly increased defense spending, and didn't
cut domestic spending enough to make up the difference. Also, the deep recession
of the early 1980s reduced revenues, raising the deficit and forcing the
Government to spend much more on paying interest for the national debt at a time
when interest rates were high. As a result, the national debt grew in size after
1980. It grew from $709 billion to $3.6 trillion in 1990, only one decade later.

Increase of National Debt Since 1980
Month Amount
--------------------------------------------
12/31/1980 $930,210,000,000.00 *
12/31/1981 $1,028,729,000,000.00 *
12/31/1982 $1,197,073,000,000.00 *
12/31/1983 $1,410,702,000,000.00 *
12/31/1984 $1,662,966,000,000.00 *
12/31/1985 $1,945,941,616,459.88
12/31/1986 $2,214,834,532,586.43
12/31/1987 $2,431,715,264,976.86
12/30/1988 $2,684,391,916,571.41
12/29/1989 $2,952,994,244,624.71
12/31/1990 $3,364,820,230,276.86
12/31/1991 $3,801,698,272,862.02
12/31/1992 $4,177,009,244,468.77
12/31/1993 $4,535,687,054,406.14
12/30/1994 $4,800,149,946,143.75
10/31/1995 $4,985,262,110,021.06
11/30/1995 $4,989,329,926,644.31
12/29/1995 $4,988,664,979,014.54
01/31/1996 $4,987,436,358,165.20
02/29/1996 $5,017,040,703,255.02
03/29/1996 $5,117,786,366,014.56
04/30/1996 $5,102,048,827,234.22
05/31/1996 $5,128,508,504,892.80
06/28/1996 $5,161,075,688,140.93
07/31/1996 $5,188,888,625,925.87
08/30/1996 $5,208,303,439,417.93
09/30/1996 $5,224,810,939,135.73
10/01/1996 $5,234,730,786,626.50
10/02/1996 $5,235,509,457,452.56
10/03/1996 $5,222,192,137,251.62
10/04/1996 $5,222,049,625,819.53

* Rounded to Millions

Federal spending has grown over the years, especially starting in the
1930s in actual dollars and in proportion to the economy (Gross Domestic Product,
or GDP).
Beginning with the "New Deal" in the 1930s, the Federal Government came
to play a much larger role in American life. President Franklin D. Roosevelt
sought to use the full powers of his office to end the Great Depression. He and
Congress greatly expanded Federal programs. Federal spending, which totaled less
than $4 billion in 1931, went up to nearly $7 billion in 1934 and to over $8
billion in 1936. Then, U.S. entry into World War II sent annual Federal spending
soaring to over $91 billion by 1944. Thus began the ever increasing debt of the
United States.
What if the debt is not increasing as fast as we think it is? The dollar
amount of the debt may increase but often times so does the amount of money or
GDP to pay for the debt. This brings up the idea that the deficit could be run
without cost.
How could a deficit increase productivity without any cost? The idea of
having a balanced budget is challenged by the ideas of Keynesian Economics.
Keynesian economics is an economic model that predicts in times of low demand
and high unemployment a deficit will not cost anything. Instead a deficit
would allow more people to work, increasing productivity. A deficit does this
because it is invested into the economy by government. For example if the
government spends deficit money on new highways, trucking will benefit and more
jobs will be produced. When an economic system is in recession all of its
resources are not being used. For example if the government did not build
highways we could not ship goods and there would be less demand for them. The
supply remains low even though we have the ability to produce more because we
cannot ship them. This non-productivity comes at a cost to the whole economic
system. If deficit spending eliminates non-productivity then its direct monetary
cost will be offset if not surpassed by increased productivity. For example in
the 1980's when the huge deficits were adding up the actual additions to the
public capital or increased productivity were often as big, or bigger than the
deficit. This means as long as the government spends the money it gains from a
deficit on assets that increase its wealth and productivity, the debt actually
benefits the economy. But, what if the government spends money on programs that
do not increase its assets or productivity. For instance consider small
businesses. If the company invests money to higher a new salesman then he will
probably increase sales and the company will regain what it spent hiring him. If
the company spends money on a paper clips when they have staplers they will just
lose the money spent on the paper clips. This frivolous spending is what makes
a deficit dangerous. Then the governments net worth decreases putting it into
serious debt.
Debt should not be a problem because we can just borrow more, right?
This statement would be correct if our ability to borrow was unlimited, but it
is not. At first the government borrowed internally from private sectors. The
government did this by selling bonds to the private sectors essentially
reallocating its own countries funds to spend on its country. This works fine
in a recession, but when the country is at or near its full capability for
production it cannot increase supply through investment of deficit dollars.
Deficit dollars then translate into demand for goods that aren't being produced.
Referring back to the small business example, if a company is selling all the
products it can produce they can still higher another salesman. But since there
are no more goods to be sold the salesman only increases the number of consumers
demanding the product. Without actually increasing sales.
The problems of deficit spending out of a recession even out through two
negative possibilities, inflation and crowding out. Inflation means there is
more demand or money than there are goods this causes an increase in prices and
drives down the worth of the dollar. This depreciation of the dollar counters
the cost of the deficit but destroys the purchasing power of the dollar. A five
dollar debt is still a five dollar debt even if the five dollars are only worth
what used to be a five cent piece of bubblegum. Despite its dangers inflation is
used to some extent to curb the debt. Crowding out is when the government is
looking for the same capital that the business sector wants to invest. This
causes fierce competition for funds to invest. The fierce competition causes an
increase in interest rates and often business will decide against further
investment and growth. The government may have the money to build new highways
but the truckers cannot afford trucks to use on them. The governments needs will
"crowd out" business needs. This turns potential assets into waste.
However, there is a third option which would allow the government to run
a deficit and avoid the negative aspects of inflation and crowding out.
Borrowing from foreign sources is a tangible and recently very common practice.
Attracted by high interest rates and stability, foreigners now buy huge amounts
of U.S. national debt. Of course this cannot be the perfect solution otherwise
no one would be concerned about the debt. The problem with borrowing from
external sources is the lack of control the government has over foreign currency
and debts. Internal debts can be paid with increased taxes, inflation, and other
monetary controls the government has but external debts can extremely damaging
to a country if it cannot buy enough of the foreign currency to pay the interest.

Running a deficit is apparently good for an economy that is operating
inside its production possibilities curve but it can be damaging to an economy
operating on the curve. A deficit managed properly has the effect of increasing
demands. An economy inside its curve can increase supplies in reaction. An
economy on the curve can increase demand but its supplies cannot increase
causing prices to rise, or inflation. If there is no deficit and the curve
shifts to the right then supplies will not increase and the country will no
longer be operating on the curve. A deficit must be maintained to insure that
the economy grows with its resources.
Is the U.S.'s current debt bad or good? The trick is finding out how
large the deficit should be in order to allow for growth without waste. The
U.S.'s deficit is bad at this point because the U.S. is close to its maximum
production capabilities, and deficit money is being wasted. For example two of
the largest portions of the budget: defense and social security. Defense
spending produces little or nothing except in times of war. Judging by the
current status of the United States as the only existing "Nuclear Super Power"
war is not a tangible event in the near or distant future. The way social
security is managed creates a huge waste. As managed, social security is money
spent to immobilize a large and fairly capable part of the work force. It
encourages elderly people not to work by spending deficit money on them.
Reducing productivity and increasing the debt at the same time. In its current
state the U.S. should attempt to reduce its deficit but eliminating it is not
necessary and could do more damage than good.