Deficit spending
[2] Government deficit spending is a central point of controversy in economics, with prominent economists holding differing views.
The deficit spending requested by John Maynard Keynes for overcoming crises is the monetary side of his economy theory.
Therefore, the excess saving of money in time of crisis should correspond to increased levels of borrowing, as this generally doesn't happen - the result is intensification of the crisis, as revenues from which money could be saved decline while a higher level of debt is needed to compensate for the collapsing revenues.
This added purchasing power, when spent, provides markets for private production, inducing producers to invest in additional plant capacity, which will form part of the real heritage left to the future.
Deficits in excess of a gap growing as a result of the maximum feasible growth in real output might indeed cause problems, but we are nowhere near that level.
If General Motors, AT&T, and individual households had been required to balance their budgets in the manner being applied to the Federal government, there would be no corporate bonds, no mortgages, no bank loans, and many fewer automobiles, telephones, and houses.
"Advocates of fiscal conservatism reject Keynesianism by arguing that government should always run a balanced budget (and a surplus to pay down any outstanding debt), and that deficit spending is always bad policy.
This view is summarized as: But it is hard to understand how the concept of "budget busting" applies to a government which, as a sovereign issuer of its own currency, can always create dollars to spend.
[citation needed] Chartalism is a small minority view in economics; while it has had advocates over the years, and influenced Keynes, who specifically credited it,[8] A notable proponent was Ukrainian-American economist Abba P. Lerner, who founded the school of Neo-Chartalism, and advocated deficit spending in his theory of functional finance.
Following John Maynard Keynes, many economists recommend deficit spending to moderate or end a recession, especially a severe one.
This raises the real gross domestic product (GDP) and the employment of labour, and if all else is constant, lowers the unemployment rate.
The increased size of the market, due to government deficits, can further stimulate the economy by raising business profitability and spurring optimism, which encourages private fixed investment in factories, machines, and the like to rise.
Also, if the government's deficit is spent on such things as infrastructure, basic research, public health, and education, that can also increase potential output in the long run.
Finally, the high demand that a government deficit provides may actually allow greater growth of potential supply, following Verdoorn's law.
If equilibrium is located on the classical range of the supply graph, an increase in government spending will lead to inflation without affecting unemployment.
[citation needed] Many economists believe government deficits influence the economy through the loanable funds market, whose existence Chartalists and other Post-Keynesians dispute.
Rising interest rates can crowd out, or discourage, fixed private investment spending, canceling out some or even all of the demand stimulus arising from the deficit—and perhaps hurting long-term supply-side growth.
Thus, crowding out is a problem only when the economy is already close to full employment (say, at about 4% unemployment) and the scope for increasing income and saving is blocked by resource constraints (potential output).
The most important burden of this debt is the interest that must be paid to bond-holders, which restricts a government's ability to raise its outlays or cut taxes to attain other goals.
Usually when economists use the term "crowding out" they are referring to the government spending using up financial and other resources that would otherwise be used by private enterprise.
Most economists favor the use of automatic stabilization over active or discretionary use of deficits to fight mild recessions (or surpluses to combat inflation).
For example, President John F. Kennedy proposed tax cuts in response to the high unemployment of 1960, but these were instituted only in 1964 and impacted the economy only in 1965 or 1966 and the increased debt encouraged inflation, reinforcing the effect of Vietnam war deficit spending.
According to them, this would lead to continued "deterioration" of the debt-to-GDP ratio, a basic measure of the health of an economy and an indication of the country's ability to pay off its debts.
Monetising the debt can lead to high levels of inflation, but with proper fiscal control this can be minimised or even avoided[citation needed].
A government may also knowingly plan the budget to be in deficit in order to sustain the country's standard of living and continue its obligations to the citizens, although this would generally be an indication of poor economic management.
Treasury showed that despite a run of large and often unexpected headline surpluses, the Australian economy was in fact in structural deficit from at least 2006–2007, and was deteriorating as far back as 2002–2003.
[13] This structural deficit was caused by a mining boom leading to extremely high revenues and large surpluses for several consecutive years, which the Howard government then used to fuel spending and tax cuts, rather than saving or investing them to cover future cyclical downturns.
With the Global Financial Crisis unexpectedly starting in 2007, revenues quickly and significantly declined and the underlying structural deficit was exposed and exacerbated, which then had to be dealt with by later governments.
[18] Martin Wolf argues that nobody knows what the structural or cyclically adjusted balance is, and that it is least knowable precisely when such knowledge is most essential, namely, when the economy is experiencing a boom.
He provides two examples of widely divergent IMF estimates of the average structural fiscal balance of Ireland and Spain for the period 2000–2007.
