US Budget Deficit Good Or Bad

Essay, Research Paper

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 wanted to use the full powers of his office to put an end the Great Depression. He and Congress greatly expanded Federal programs. Federal spending, which totaled less than $4 billion in 1931, went up to almost $7 billion in 1934 and to over $8 billion in 1936. Then the U.S. entry into World War II sent annual Federal spending to over $91 billion by 1944 (Evans 7-9). As the federal government thus became a primary participant in the nation s economic activity, the era of big federal government spending began (Davis 18). However, is running a deficit a good idea? There are several reasons that show how it is both good and bad.

What if the debt is not increasing as fast as we think it is? The debt may increase in dollar amount but often times so does the amount of money or GDP to pay for the debt. This gives us the idea that the deficit could be run without cost. How then could a deficit increase productivity without any cost? The idea of having a balanced budget is challenged by the ideas of Keynesian Economics (Makin and Ornstein 14, 120-122). Keynesian economics is an economic model that predicts that in times of low demand and high unemployment, a deficit will not cost anything (Gordon 132-136). 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 changed if not exceeded 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 and this meant 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.

What if the government spends money on programs that do not increase its assets or productivity? For example small businesses. If the company invests money to hire 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 paper clips when they have staplers they will lose the money spent on the paper clips. This unneeded spending is what makes a deficit dangerous because the governments net worth decreases which puts it into serious debt.

Debt should not be a problem because we can just borrow more, right? This 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 relocating its own countries funds to spend on its country (Cavanaugh 37). 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. This is because deficit dollars then translate into demand for goods that aren t being produced. Going back to the small business example, if a company is selling all the products it can produce, they can still hire another salesman. But because there are no more goods to be sold, the salesman would only increase the number of consumers demanding the product without increasing sales. The problems of deficit spending out of a recession evens out through two possibilities which are both negative, 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 one dollar. Crowding out is when the government is looking for the same capital that the business sector wants to invest (Cavanaugh 37-38). 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 (Evans 200-203). 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.

However, there is a third option which would allow the government to run a deficit and avoid the negative effects of inflation and crowding out. That option is borrowing from foreign sources. Because of the attractive high interest rates and stability, foreigners now buy huge amounts of U.S. national debt. This is not the perfect solution because if it was, no one would be concerned about the debt. The problem with borrowing from external sources is the lack of control the government has on 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 but it can be damaging to an economy that is not. A deficit managed properly has the effect of increasing demands. An economy running inside its production possibilities can increase supplies in reaction but an economy that is not can increase demand but its supplies cannot increase causing prices to rise, or inflation. If there is no deficit, then supplies will not increase. A deficit must be maintained to insure that the economy grows with its resources.