Deficit spending can be a divisive topic among economists and politicians, especially in times of crisis. Economic theories in support of deficit spending claim its use can revitalize a sluggish economic state. While some — like David Ricardo, who actively opposed deficit spending due to the consequential tax repercussions — believe deficit spending is dangerous. Like any policy or measure, deficit spending can be instrumental in maintaining a healthy economy, so long as its purpose is clear. The matter isn’t whether deficit spending is exclusively “good” or “bad”, but how countries can best use it to rebuild or reprogram their economy.
What is deficit spending?
Deficit spending was a concept first popularized by John Maynard Keynes in the 1940’s. However, it was only considered to be accepted by the United States government in the 1950’s, after the federal government ran the largest deficit based on percentage of the Gross Domestic Product (GDP) in the late 40's. Deficit spending can be defined as a government’s deliberate excess spending to gather capital in a means other than taxation. This allows governments to accumulate capital needed for social programs, education, and benefits without directly raising taxes. This becomes an important justification for the use of deficit spending during an economic depression.
With the use of deficit spending, a country can focus on providing for its population during economic hardship and simultaneously encourage consumer spending to signal the recovery phase. The Keynesian Multiplier (also known as the multiplier effect) maintains that a steady economic recovery can be achieved and even ignited by government spending. The Keynesian Multiplier offers that for every $1 spent by the government, there is an economic boost of more than $1. In keeping with this theory, deficit spending could be considered an investment, with increased consumer spending acting as a return.
Why could it be dangerous?
Deficit spending is a loan — and like any loan, capital borrowed is capital that needs to be returned. Deficit spending is an opportunity for governments to amass capital without directly raising taxes, but as the economy adapts and changes, taxpayers are likely to be affected eventually. Economist David Ricardo advocated against deficit spending, and his theory (Ricardian Theory) suggests that “government deficit spending is equivalent to spending out of current taxes”. From a psychology perspective, Ricardo argues that the eventuality of higher taxes will inhibit consumer spending, counteracting the deficit’s purpose.
In the early 1990’s, Sweden’s economy entered a volatile state: banks were filing for bankruptcy, and unemployment rates were skyrocketing as quickly as the GDP had plummeted. A trend of rising prices throughout the 1970’s and 1980’s had triggered an economic nightmare. Sweden’s economy needed to be restructured to recover. By increasing exports and focusing on appropriate deficit spending, Sweden’s economy made a comeback by the late 1990’s.
Sweden’s economic recovery wasn’t possible because of increased spending; it was enabled by calculated and well-planned deficit spending. Deficit spending alone can’t save a flailing economy; however, when accompanied by diligent leadership and a well-founded plan, it can be a powerful mechanism.
How should we use deficit spending?
Deficit spending is not so different from other economic policy. Despite its mutuality between nations, deficit spending is merely a utensil to be employed by governments to improve the macroeconomics of a nation. With this knowledge, we should be receptive to responsibly managed deficit spending so long as the capital borrowed works toward the public good.
Investing in research, infrastructure and innovation will ensure a return on our spending. As we head forth into our second year of the pandemic, many more Canadians are finding evidence of deficit spending in their daily lives: from response benefits to vaccine research. As long as we continue to borrow smartly, and use our capital to protect and cater to our population, deficit spending can be a successful piece in our repertoire.
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