Economics-When can deficits actually help the economy?

When can deficits actually help the economy and why do deficits rise during recessions?

3 Answers

  • 1 decade ago
    Favorite Answer

    Deficits can help the economy because the government's spending to create the deficit can spur growth in the private sector. If enough growth occurs, the government can (theoretically) balance out the deficit with the additional tax revenue - though it takes time and is easier in theory than in practice.

    A recession is defined as six consecutive months of declining growth. When companies don't grow as much (or at all) tax revenues do not grow either (assuming tax law is constant). This can cause a deficit because the government has allocated spending for dollars that it now will not generate, so it must either cut spending or change the tax law to generate revenue.

  • 1 decade ago

    I assume you mean a budget deficit, rather than a trade deficit (since a trade deficit is likely to fall during recessions).

    A budget deficit means that the government is spending more money than it earns, and therefore eating away at reserves, increasing the national debt, or using other methods to fund this.

    This can be beneficial because governments tend to spend money on their own country. For example, if the US government wants to build a new highway, they are likely to employ a US construction company, engineers etc. This has a multiplying effect, because the American engineer who now gets a larger salary, will in turn spend more at American businesses. He may buy a new car, TV or whatever - the net result is that other parts of the economy benefit even though the government only increased pay to one person (or a few people). The result of this can be greater employment, as demand for products rise and so factories employ more people, etc. All of this helps the economy.

    During the time of the Great Depression, it is argued that one of the reasons that Germany was less affected than other Western countries was that while the leaders of the US and UK focused on cutting spending (since they had less money due to the depression), Hitler increased spending, which in turn created more jobs for Germans and so on. Of course, we'd all rather that he hadn't increased military spending, but that's a historical example. It seems illogical that a government might want to spend even more than usual when they have less money, but that's the theory - that by deliberately creating a deficit, it can stimulate the economy and therefore result in more growth in the future.

    Why do they rise during recessions? That's one reason, that sometimes governments cause them to rise deliberately. However a more common reason is that's simply one of the effects of a recession. People earn less, spend less, save more - therefore the government gets less tax revenue. People become unemployed, therefore the government has to pay more social security benefits. Less income and more expenses means a greater deficit.

  • 1 decade ago

    Sherry gave a great answer. To add to it, deficits can be good for the economy when they're being used to fund future growth. The deficits of the depression era spurred road building, hydro-electric damns, municipal waste treatment, etc. They put people to work and created projects that formed the basis of a recovery. Yes, WWII spurred the economic recovery into overdrive. But the USA was well on it's way before Pearl Harbor.

    Think of a personal debt as a deficit and it might help. When you go into debt just to wear trendy clothes and to eat out, it's not a good thing. It's a drain on you. But when you go into debt to be trained for a higher paying job, or for functional work clothes, or for real estate; then your personal deficit is funding yourr future and hopefully higher income.

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