Within the
budgetary process, deficit spending is the amount by which spending exceeds
revenue
In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business.
Commercial revenue may also be referred to as sales or as turnover. Some companies receive reven ...
over a particular period of time, also called simply deficit, or budget deficit; the opposite of
budget surplus. The term may be applied to the budget of a government, private company, or individual. Government deficit spending was first identified as a necessary economic tool by
John Maynard Keynes
John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946), was an English economist whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originally trained in ...
in the wake of the
Great Depression. It is a central point of controversy in economics, as discussed below.
Controversy
Government deficit spending is a central point of controversy in economics, with prominent economists holding differing views.
The
mainstream economics position is that deficit spending is desirable and necessary as part of
countercyclical
Procyclical and countercyclical variables are variables that fluctuate in a way that is positively or negatively correlated with business cycle fluctuations in gross domestic product (GDP). The scope of the concept may differ between the context ...
fiscal policy
In economics and political science, fiscal policy is the use of government revenue collection (taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variab ...
, but that there should not be a
structural deficit (i.e., permanent deficit): The government should run deficits during
recession
In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be triggered by various ...
s to compensate for the shortfall in
aggregate demand, but should run surpluses in boom times so that there is no net deficit over an
economic cycle
Business cycles are intervals of expansion followed by recession in economic activity. These changes have implications for the welfare of the broad population as well as for private institutions. Typically business cycles are measured by examini ...
(i.e., only run
cyclical deficit
Within the budgetary process, deficit spending is the amount by which spending exceeds revenue over a particular period of time, also called simply deficit, or budget deficit; the opposite of budget surplus. The term may be applied to the budget ...
s and not structural deficits). This is derived from
Keynesian economics
Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomic theories and models of how aggregate demand (total spending in the economy) strongly influences economic output a ...
, and gained acceptance during the period between the
Great Depression in the 1930s and
post-WWII in the 1950s.
This position is attacked from both sides: Advocates of federal-level
fiscal conservatism argue that deficit spending is always bad policy, while some
post-Keynesian
Post-Keynesian economics is a school of economic thought with its origins in '' The General Theory'' of John Maynard Keynes, with subsequent development influenced to a large degree by Michał Kalecki, Joan Robinson, Nicholas Kaldor, Sidney ...
economists—particularly
neo-chartalists or proponents of
Modern Monetary Theory
Modern Monetary Theory or Modern Money Theory (MMT) is a heterodox
*
*
*
*
*
* macroeconomic theory that describes currency as a public monopoly and unemployment as evidence that a currency monopolist is overly restricting the supply of t ...
—argue that deficit spending is necessary for the issuance of new money, and not only for fiscal stimulus. According to most economists, during recessions, the government can stimulate the economy by intentionally running a deficit.
The deficit spending requested by
John Maynard Keynes
John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946), was an English economist whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originally trained in ...
for overcoming crises is the monetary side of his economy theory. As investment equates to real saving, money assets that build up are equivalent to debt capacity. 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. The state's deficit enables a correspondent buildup of money assets for the private sector and prevents the breakdown of the economy, preventing private money savings to be run down by private debt.
The monetary mechanism describing how revenue surpluses enforce corresponding expense surpluses, and how these in turn lead to economic breakdown was explained by
Wolfgang Stützel
Wolfgang Stützel (23 January 1925, in Aalen, Germany – 1 March 1987, in Saarbrücken, West Germany) was a German economist and professor of economics at the Saarland University, Germany. From 1966 to 1968 he was member of the German Council ...
much later by the means of his
Balances Mechanics
The Balances Mechanics (german: Saldenmechanik; from balances of bookkeeping respectively the credit system and mechanics to characterize the strict universal identities) is a work and mean of economics, comparable with Stock-Flow Consistent Model ...
.
William Vickrey
William Spencer Vickrey (21 June 1914 – 11 October 1996) was a Canadian-American professor of economics and Nobel Laureate. Vickrey was awarded the 1996 Nobel Memorial Prize in Economic Sciences with James Mirrlees for their research into the e ...
, awarded the 1996 Nobel Memorial Prize in Economic Sciences, identified deficits being viewed as profligate spending as his #1 fallacy of Financial Fundamentalism when he commented:
Fiscal conservatism
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. The
neoclassical-inclined
Chicago school of economics has supported fiscal conservative ideas. Numerous states of the United States have a
balanced budget amendment to their state constitution, and the
Stability and Growth Pact
The Stability and Growth Pact (SGP) is an agreement, among all of the 27 member states of the European Union, to facilitate and maintain the stability of the Economic and Monetary Union (EMU). Based primarily on Articles 121 and 126 of the Tre ...
of the
European Monetary Union
The economic and monetary union (EMU) of the European Union is a group of policies aimed at converging the economies of member states of the European Union at three stages.
There are three stages of the EMU, each of which consists of prog ...
punishing government deficits of 3% of GDP or greater.
Proponents of fiscal conservatism date back to
Adam Smith, founder of modern economics. Fiscal conservatism was the dominant position until the Great Depression, associated with the
gold standard
A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. The gold standard was the basis for the international monetary system from the 1870s to the early 1920s, and from the l ...
and expressed in the now outdated
Treasury View
In macroeconomics, particularly in the history of economic thought, the Treasury view is the assertion that fiscal policy has ''no'' effect on the total amount of economic activity and unemployment, even during times of economic recession. This v ...
that government fiscal policy is ineffective.
The usual argument against deficit spending is the
Government-Household analogy: ''households'' should not run deficits—one should have money before one spends it, from prudence—and that what is correct for a household is correct for a nation and its government. A similar argument is that deficit spending today will require increased taxation in the future, thus burdening future generations. (See
generational accounting
Generational accounting is a method of measuring the fiscal burdens facing current and future generations. Generational accounting considers how much each adult generation, on a per person basis, is likely to pay in future taxes net of transfer p ...
for discussion.)
Others argue that because debt is both owed ''by'' and owed ''to'' private individuals, there is no ''net'' debt burden of government debt, just wealth transfer (redistribution) from those who owe debt (government, backed by tax payers) to those who hold debt (holders of government bonds).
A related line of argument, associated with the
Austrian school of economics, is that government deficits are
inflationary Inflationism is a heterodox economic, fiscal, or monetary policy, that predicts that a substantial level of inflation is harmless, desirable or even advantageous. Similarly, inflationist economists advocate for an inflationist policy.
Mainstream ec ...
. Anything other than mild or moderate inflation is generally accepted in economics to be a bad thing. In practice this is argued to be because governments pay off debts by printing money, increasing the money supply and creating inflation, and is taken further by some as an argument against fiat money and in favor of
hard money, especially the gold standard.
Post-Keynesian economics
Some Post-Keynesian economists argue that deficit spending is ''necessary,'' either to create the money supply (Chartalism) or to satisfy demand for savings in excess of what can be satisfied by private investment.
Chartalists argue that deficit spending is logically necessary because, in their view,
fiat money
Fiat money (from la, fiat, "let it be done") is a type of currency that is not backed by any commodity such as gold or silver. It is typically designated by the issuing government to be legal tender. Throughout history, fiat money was sometim ...
is ''created'' by deficit spending: fiat money cannot be collected in taxes before it is issued ''and spent''; the amount of fiat money in circulation is exactly the
government debt
A country's gross government debt (also called public debt, or sovereign debt) is the financial liabilities of the government sector. Changes in government debt over time reflect primarily borrowing due to past government deficits. A deficit oc ...
—money spent but not collected in taxes. In a quip, "fiat money governments are 'spend and tax', not '
tax and spend'"—deficit spending comes first.
Chartalists argue that nations are fundamentally different from households. Governments in a fiat money system which only have debt in their own currency can issue other liabilities, their fiat money, to pay off their interest bearing bond debt. They cannot go bankrupt involuntarily because this fiat money is what is used in their economy to settle debts, while household liabilities are not so used. This view is summarized as:
Continuing in this vein, Chartalists argue that a structural deficit is ''necessary'' for
monetary expansion in an expanding economy: if the economy grows, the money supply should as well, which should be accomplished by government deficit spending. Private sector savings are equal to government sector deficits, to the penny. In the absence of sufficient deficit spending, money supply can increase by increasing
financial leverage
In finance, leverage (or gearing in the United Kingdom and Australia) is any technique involving borrowing funds to buy things, hoping that future profits will be many times more than the cost of borrowing. This technique is named after a lever ...
in the economy—the amount of
bank money grows, while the
base money supply remains unchanged or grows at a slower rate, and thus the ratio (leverage = credit/base) increases—which can lead to a
credit bubble
An economic bubble (also called a speculative bubble or a financial bubble) is a period when current asset prices greatly exceed their intrinsic valuation, being the valuation that the underlying long-term fundamentals justify. Bubbles can be ...
and a
financial crisis
A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and man ...
.
Chartalism is a small minority view in economics; while it has had advocates over the years, and influenced Keynes, who specifically credited it, A notable proponent was Ukrainian-American economist
Abba P. Lerner
Abraham "Abba" Ptachya Lerner (also Abba Psachia Lerner; 28 October 1903 – 27 October 1982) was a Russian-born American-British economist.
Biography
Born in Novoselytsia, Bessarabia, Russian Empire, Lerner grew up in a Jewish family, which e ...
, who founded the school of
Neo-Chartalism
Modern Monetary Theory or Modern Money Theory (MMT) is a Heterodox economics, heterodox
*
*
*
*
*
* macroeconomic theory that describes currency as a public monopoly and unemployment as evidence that a currency monopolist is overly restri ...
, and advocated deficit spending in his theory of
functional finance Functional finance is an economic theory proposed by Abba P. Lerner, based on effective demand principles and chartalism. It states that government should finance itself to meet explicit goals, such as taming the business cycle, achieving full emp ...
. A contemporary center of Neo-Chartalism is the
Kansas City School of economics.
Chartalists, like other Keynesians, accept the
paradox of thrift
The paradox of thrift (or paradox of saving) is a paradox of economics. The paradox states that an increase in autonomous saving leads to a decrease in aggregate demand and thus a decrease in gross output which will in turn lower ''total'' saving ...
, which argues that identifying behavior of individual households and the nation as a whole commits the
fallacy of composition
The fallacy of composition is an informal fallacy that arises when one infers that something is true of the whole from the fact that it is true of some part of the whole. A trivial example might be: "This tire is made of rubber, therefore the ve ...
; while the paradox of thrift (and thus deficit spending for fiscal stimulus) is widely accepted in economics, the Chartalist form is not.
An alternative argument for the necessity of deficits was given by U.S. economist
William Vickrey
William Spencer Vickrey (21 June 1914 – 11 October 1996) was a Canadian-American professor of economics and Nobel Laureate. Vickrey was awarded the 1996 Nobel Memorial Prize in Economic Sciences with James Mirrlees for their research into the e ...
, who argued that deficits were necessary to satisfy demand for savings in excess of what can be satisfied by private investment.
Government deficits
When the outlay of a government (i.e., the total of its purchases of goods and services, transfers in grants to individuals and corporations, and its net interest payments) exceeds its tax
revenue
In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business.
Commercial revenue may also be referred to as sales or as turnover. Some companies receive reven ...
s, the government budget is said to be in
deficit; government spending in excess of tax receipts is known as deficit spending.
Governments usually issue
bonds to match their deficits. They can be bought by its
Central Bank
A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union,
and oversees their commercial banking system. In contrast to a commercial bank, a central b ...
through
open market operations
In macroeconomics, an open market operation (OMO) is an activity by a central bank to give (or take) liquidity in its currency to (or from) a bank or a group of banks. The central bank can either buy or sell government bonds (or other financial a ...
. Otherwise the debt issuance can increase the level of (i) public debt, (ii) private sector net worth, (iii) debt service (interest payments), and (iv) interest rates. (See
Crowding out below.) Deficit spending may, however, be consistent with public debt remaining stable as a proportion of
GDP
Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjective nature this measure is ofte ...
, depending on the level of GDP growth.
The opposite of a budget deficit is a
budget surplus; in this case, tax revenues exceed government purchases and transfer payments. For the public sector to be in deficit implies that the private sector (domestic and foreign) is in surplus. An increase in public indebtedness must necessarily therefore correspond to an equal decrease in private sector net indebtedness. In other words, deficit spending permits the private sector to accumulate net worth.
On average, through the economic cycle, most governments have tended to run budget deficits, as can be seen from the
large debt balances accumulated by governments across the world.
Keynesian effect
Following
John Maynard Keynes
John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946), was an English economist whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originally trained in ...
, many
economist
An economist is a professional and practitioner in the social science discipline of economics.
The individual may also study, develop, and apply theories and concepts from economics and write about economic policy. Within this field there are ...
s recommend deficit spending to moderate or end a
recession
In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be triggered by various ...
, especially a severe one. When the economy has high unemployment, an increase in government purchases creates a market for business output, creating income and encouraging increases in
consumer spending
Consumer spending is the total money spent on final goods and services by individuals and households.
There are two components of consumer spending: induced consumption (which is affected by the level of income) and autonomous consumption (which ...
, which creates further increases in the demand for business output. (This is the
multiplier effect
In macroeconomics, a multiplier is a factor of proportionality that measures how much an endogenous variable changes in response to a change in some exogenous variable.
For example, suppose variable ''x''
changes by ''k'' units, which causes an ...
.) This raises the real
gross domestic product
Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjective nature this measure is oft ...
(GDP) and the employment of labour, and if all else is constant, lowers the unemployment rate. (The connection between demand for GDP and unemployment is called
Okun's law
In economics, Okun's law is an empirically observed relationship between unemployment and losses in a country's production. It is named after Arthur Melvin Okun, who first proposed the relationship in 1962. The "gap version" states that for ever ...
.)
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. This
accelerator effect
The accelerator effect in economics is a positive effect on private fixed investment of the growth of the market economy (measured e.g. by a change in Gross Domestic Product). Rising GDP (an economic boom or prosperity) implies that businesses in g ...
stimulates demand further and encourages rising employment.
Similarly, running a government surplus or reducing its deficit reduces consumer and business spending and raises unemployment. This can lower the inflation rate. Any use of the government deficit to steer the macro-economy is called
fiscal policy
In economics and political science, fiscal policy is the use of government revenue collection (taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variab ...
.
A deficit does not simply stimulate demand. If private investment is stimulated, that increases the ability of the economy to supply
output
Output may refer to:
* The information produced by a computer, see Input/output
* An output state of a system, see state (computer science)
* Output (economics), the amount of goods and services produced
** Gross output in economics, the value o ...
in the long run. 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
Verdoorn's law is named after Dutch economist Petrus Johannes Verdoorn (1949). It states that in the long run productivity generally grows proportionally to the square root of output. In economics, this law pertains to the relationship between the ...
.
Deficit spending may create
inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
, or encourage existing inflation to persist. For example, in the
United States
The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territori ...
Vietnam-war era deficits encouraged inflation. This is especially true at low unemployment rates. But government deficits are not the only cause of inflation: It can arise due to such supply-side shocks as the oil crises of the 1970s and inflation left over from the past (e.g., inflationary expectations and the
price/wage spiral
In macroeconomics, a wage-price spiral (also called a wage/price spiral or price/wage spiral) is a proposed explanation for inflation, in which wage increases cause price increases which in turn cause wage increases, in a positive feedback loop. Gr ...
).
If equilibrium is located on the
classical range of the supply graph, an increase in government spending will lead to inflation without affecting unemployment. There must also be enough money circulating in the system to allow inflation to persist, so that inflation depends on
monetary policy
Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money supply, often a ...
.
Loanable funds
Many economists believe government deficits influence the economy through the
loanable funds market, whose existence Chartalists and other Post-Keynesians dispute. Government borrowing in this market increases the demand for loanable funds and thus (ignoring other changes) pushes up interest rates. 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.
Increased deficits also raise the amount of total income received, which raises the amount of saving done by individuals and corporations and thus the supply of loanable funds, lowering interest rates. 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
In economics, potential output (also referred to as "natural gross domestic product") refers to the highest level of real gross domestic product (potential output) that can be sustained over the long term. Actual output happens in real life while ...
).
Despite a government debt that exceeded GDP in 1945, the U.S. saw the long prosperity of the 1950s and 1960s. The growth of the
supply side
Supply-side economics is a Macroeconomics, macroeconomic theory that postulates economic growth can be most effectively fostered by Tax cuts, lowering taxes, Deregulation, decreasing regulation, and allowing free trade. According to supply-sid ...
, it seems, was not hurt by the large deficits and debts.
A government deficit increases
government debt
A country's gross government debt (also called public debt, or sovereign debt) is the financial liabilities of the government sector. Changes in government debt over time reflect primarily borrowing due to past government deficits. A deficit oc ...
. In many countries the government borrows by selling bonds rather than borrowing from banks. 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.
Crowding out
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. However, some commentators use "crowding out" to refer to government providing a service or good that would otherwise be a business opportunity for private industry.
Unintentional deficits
National government deficits may be intentional, a result of policy decisions, or unintentional. When an economy goes into a recession, deficits usually rise in the more affluent countries. Revenue from progressive taxes based on economic activity (income, expenditure, or transactions) falls. Other sources of tax revenue such as
wealth tax
A wealth tax (also called a capital tax or equity tax) is a tax on an entity's holdings of assets. This includes the total value of personal assets, including cash, bank deposits, real estate, assets in insurance and pension plans, ownershi ...
es, notably
property tax
A property tax or millage rate is an ad valorem tax on the value of a property.In the OECD classification scheme, tax on property includes "taxes on immovable property or net wealth, taxes on the change of ownership of property through inhe ...
es, are not subject to recessions, though they are subject to asset price bubbles. Transfer payments due to increased unemployment and reduced household income rise.
Automatic vs. active deficit policies
Most economists favor the use of
automatic stabilization over active or discretionary use of deficits to fight mild recessions (or surpluses to combat inflation). Active policy-making takes too long for politicians to institute and too long to affect the economy. Often, the medicine ends up affecting the economy only after its disease has been cured, leaving the economy with side-effects such as inflation. For example, President
John F. Kennedy
John Fitzgerald Kennedy (May 29, 1917 – November 22, 1963), often referred to by his initials JFK and the nickname Jack, was an American politician who served as the 35th president of the United States from 1961 until his assassination ...
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.
Structural and cyclical deficit
Structural and cyclical deficits are two components of deficit spending. These terms are especially applied to
public sector
The public sector, also called the state sector, is the part of the economy composed of both public services and public enterprises. Public sectors include the public goods and governmental services such as the military, law enforcement, inf ...
spending which contributes to the
budget balance of the overall
economy
An economy is an area of the production, distribution and trade, as well as consumption of goods and services. In general, it is defined as a social domain that emphasize the practices, discourses, and material expressions associated with the ...
of a country. The total budget deficit, or headline deficit, is equal to the sum of the structural deficit and the cyclical deficit (or surplus/es).
Cyclical deficit
A cyclical (temporary) deficit is a deficit that is related to the
business or economic cycle. The business cycle is the period of time it takes for an economy to move from
expansion to
contraction, until it begins to expand again. This cycle can last anywhere from several months to many years, and does not follow a predictable pattern.
The cyclical deficit is the deficit experienced at the low point of this cycle when there are lower levels of business activity and higher levels of
unemployment
Unemployment, according to the OECD (Organisation for Economic Co-operation and Development), is people above a specified age (usually 15) not being in paid employment or self-employment but currently available for work during the refere ...
. This leads to lower government revenues from
taxation
A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, o ...
and higher government expenditure on things like
social security
Welfare, or commonly social welfare, is a type of government support intended to ensure that members of a society can meet basic human needs such as food and shelter. Social security may either be synonymous with welfare, or refer specifical ...
, which may cause the economy to go into deficit. While the cyclical component is affected by government decisions, it is mainly influenced by national and international economic conditions which can be significantly beyond government control.
Structural deficit
A structural (permanent) deficit differs from a cyclical deficit in that it exists regardless of the point in the business cycle due to an underlying imbalance in government revenues and expenditures. Thus, even at the high point of the business cycle when revenues are high the country's economy may still be in deficit.
The structural component of the budget is used by some economists as an indication of a government's financial management, as it indicates the underlying balance between long-term government revenues and expenditure, while removing factors that are mainly attributable to the business cycle. Other economists see the structural deficit as simply a reflection of the implied discretionary fiscal stance of the government, that is, a structural deficit would be an expansionary fiscal stance that promotes at least nominal economic growth.
Where deficits are being funded by borrowing, a structural deficit is seen by some economists as an issue for a government as even at the high points of the business cycle the government may need to continue to borrow and thus continue to accumulate
debt
Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
. 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.
Other economists believe that provided the debt is issued in the country's own currency, and provided that currency 'floats' freely against other currencies, and provided the overall level of the deficit is not so large as to cause excessive inflation, then structural deficits are harmless. Those economists who believe that structural deficits need to be reduced argue that structural deficit issues can only be addressed by explicit and direct
government policies
Public policy is an institutionalized proposal or a decided set of elements like laws, regulations, guidelines, and actions to solve or address relevant and real-world problems, guided by a conception and often implemented by programs. Public ...
, primarily involving reducing government spending or increasing
taxation
A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, o ...
.
An alternative in countries which have
fiat money
Fiat money (from la, fiat, "let it be done") is a type of currency that is not backed by any commodity such as gold or silver. It is typically designated by the issuing government to be legal tender. Throughout history, fiat money was sometim ...
is to address high levels of debt and a poor debt-to-GDP ratio by
monetising the debt, essentially
creating more money to be used to pay off the debt. Monetising the debt can lead to high levels of
inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
, but with proper fiscal control this can be minimised or even avoided. Both it and the final option of
defaulting on the debt are thought to be poor results for
investor
An investor is a person who allocates financial capital with the expectation of a future return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some species of property. Type ...
s.
There having been recent incidents involving
quantitative easing
Quantitative easing (QE) is a monetary policy action whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to stimulate economic activity. Quantitative easing is a novel form of monetary pol ...
in the UK, the U.S. and the Eurozone following the 2008 global financial crisis. These are the first instances of either since the dropping of the
gold standard
A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. The gold standard was the basis for the international monetary system from the 1870s to the early 1920s, and from the l ...
.
Structural deficits may be planned, or may be unintentional due to poor economic management or a fundamental lack of economic capacity in a country. In a planned structural deficit, the government may commit to spending money on the future of the country in order to improve the productive potential of the economy, for example investing in
infrastructure,
education
Education is a purposeful activity directed at achieving certain aims, such as transmitting knowledge or fostering skills and character traits. These aims may include the development of understanding, rationality, kindness, and honesty ...
, or
transport
Transport (in British English), or transportation (in American English), is the intentional movement of humans, animals, and goods from one location to another. Modes of transport include air, land ( rail and road), water, cable, pipelin ...
, with the intention that this investment will yield long-term economic gains. If these investments work out as planned the structural deficit will be dealt with over the long-term due to the returns on investment. However, if expenditures continue to exceed revenues, the structural deficit will worsen.
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. Ongoing planned structural deficits may eventually lead to a crisis of confidence in investors regarding the country's ability to pay the debt, as seen in the
financial crises
A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and man ...
in a number of European countries since the late-2000s, especially the
Greek
Greek may refer to:
Greece
Anything of, from, or related to Greece, a country in Southern Europe:
*Greeks, an ethnic group.
*Greek language, a branch of the Indo-European language family.
**Proto-Greek language, the assumed last common ancestor ...
and
Spanish
Spanish might refer to:
* Items from or related to Spain:
**Spaniards are a nation and ethnic group indigenous to Spain
**Spanish language, spoken in Spain and many Latin American countries
**Spanish cuisine
Other places
* Spanish, Ontario, Can ...
financial crises.
Structural and cyclical surplus
Structural and cyclical
surpluses are the opposite of the deficits described above. With a ''cyclical surplus'', at the high point of the business cycle government revenue will be expected to be higher and government expenditure lower, meaning revenue exceeds expenditure and the government experiences a surplus. Likewise, a ''structural surplus'' is when the government budget is fundamentally operating at a surplus regardless of its point in the business cycle.
Interplay of structural and cyclical components
The overall
government budget balance
The government budget balance, also alternatively referred to as general government balance, public budget balance, or public fiscal balance, is the overall difference between government revenues and spending. A positive balance is called a ' ...
is determined by the sum of the cyclical deficit or surplus and the structural deficit or surplus (refer to chart). Therefore, for example, a cyclical surplus could mask an underlying structural deficit, as the overall budget may appear to be in surplus if the cyclical surplus is greater than the structural deficit. In this case, as economic conditions deteriorated and the budget went into cyclical deficit, the structural and cyclical deficits would then compound leading to higher deficits and more dire economic conditions.
An example of this occurred in Australia during the later years of the
Howard Government. From 2009
Treasury
A treasury is either
*A government department related to finance and taxation, a finance ministry.
*A place or location where treasure, such as currency or precious items are kept. These can be state or royal property, church treasure or i ...
attempted to separate cyclical and structural components of the budget balance, and first started publishing estimates of the structural component. 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. At this time they determined that despite a headline surplus of
A$17.2 billion in 2006–2007, there was an underlying structural deficit of around $3 billion, or 0.3% of
GDP
Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjective nature this measure is ofte ...
.
This structural deficit was caused by a
mining
Mining is the extraction of valuable minerals or other geological materials from the Earth, usually from an ore body, lode, vein, seam, reef, or placer deposit. The exploitation of these deposits for raw material is based on the economic ...
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
Global means of or referring to a globe and may also refer to:
Entertainment
* ''Global'' (Paul van Dyk album), 2003
* ''Global'' (Bunji Garlin album), 2007
* ''Global'' (Humanoid album), 1989
* ''Global'' (Todd Rundgren album), 2015
* Bruno ...
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.
By 2008–2009 when the budget had a headline deficit of $32 billion, the structural deficit was out to around $50 billion.
In 2013 it was estimated the structural deficit remained at about $40 billion, or 2.5% of GDP.
Criticism
Bruce Yandle writing for
Reason
Reason is the capacity of consciously applying logic by drawing conclusions from new or existing information, with the aim of seeking the truth. It is closely associated with such characteristically human activities as philosophy, science, ...
stated in 2022 as a result of rising inflation that, "
t would be prudent toBlame Washington, Not Moscow, for Surging Inflation; Few politicians are willing to admit deficit spending is the larger cause."
Economist
An economist is a professional and practitioner in the social science discipline of economics.
The individual may also study, develop, and apply theories and concepts from economics and write about economic policy. Within this field there are ...
Chris Dillow has questioned the distinction between cyclical and structural deficits,
and this has received support from other leading economists. He contends that there are too many variables involved to allow a clear distinction to be made, especially when dealing with current circumstances rather than retrospectively, and suggests that the concept of structural deficits may be used more for
political
Politics (from , ) is the set of activities that are associated with making decisions in groups, or other forms of power relations among individuals, such as the distribution of resources or status. The branch of social science that stud ...
purposes than analytical purposes.
The piece largely centred on the UK Labour government 1997–2010 of which Chris Dillow was a strong supporter and criticism that they ran a large structural deficit. Economic representatives of that government acknowledge that, unbeknownst to them at the time, they were running a structural deficit.
Economist, Professor Bill Mitchell has also questioned the misuse of the term 'structural deficit', particularly in the Australian context.
Martin Wolf
Martin Harry Wolf (born 16 August 1946 in London) is a British journalist of Austrian-Dutch descent who focuses on economics. He is the associate editor and chief economics commentator at the ''Financial Times''.
Early life
Wolf was born in ...
, in his book "The Shifts and the Shocks",
[The Shifts and the Shocks: What We’ve Learned—and Have Still to Learn—from the Financial Crisis, p.76-77, Penguin Press 2014, ] 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. The estimates were made in 2008 and in 2012 and Wolf stresses that they were post-fact estimates and not predictions.
Specifically, in 2008, the IMF declared that Ireland had run an average structural surplus of 1.3% of GDP, per year, between 2000 and 2007, and Spain an average structural surplus of 0.5% of GDP, per year, over the same period. Then, four years later, the IMF decided that, for this same 8-year period, Ireland's annual average structural balance was four percentage points worse than it had thought in April 2008, estimating that Ireland had been running an average structural fiscal deficit of 2.7% of GDP. For Spain, the 2012 IMF estimate differed by 1.7 percentage points, estimating this time that Spain had been running and average structural fiscal deficit of 1.2% of GDP, in the years 2000–2007.
See also
*
Inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
*
Functional finance Functional finance is an economic theory proposed by Abba P. Lerner, based on effective demand principles and chartalism. It states that government should finance itself to meet explicit goals, such as taming the business cycle, achieving full emp ...
*
Deficit (disambiguation)
A deficit is the amount by which a sum falls short of some reference amount.
Economics
* Balance of payments deficit, when the balance of payments is negative
* Government budget deficit
* Deficit spending, the amount by which spending exceeds ...
*
Public debt
A country's gross government debt (also called public debt, or sovereign debt) is the financial liabilities of the government sector. Changes in government debt over time reflect primarily borrowing due to past government deficits. A deficit oc ...
*
Balanced Budget Amendment
*
Keynesian economics
Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomic theories and models of how aggregate demand (total spending in the economy) strongly influences economic output a ...
*
Fiscal policy
In economics and political science, fiscal policy is the use of government revenue collection (taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variab ...
References
*
* Mitchell, Bill
Deficit spending 101 – Part 1Part 2Part 3 Neo-Chartalist (Modern Monetary Theory) perspective on deficit spending
*
* McGregor, Michael A., Driscoll, Paul D., McDowell, Walter (2010) “Head’s Broadcasting in America: A Survey of Electronic Media”. Boston, Massachusetts: Allyn & Bacon p. 180.
Further reading
*
*
{{DEFAULTSORT:Deficit Spending
Government spending
Keynesian economics
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