Deficit Spending

Published May 15, 2023

Definition of Deficit Spending

Deficit Spending occurs when the government spends more money than it collects in taxes within a given period. This difference between spending and tax revenue creates a budget deficit. Governments will often do this to finance public projects or spur economic growth. In most cases, the government will issue bonds or borrow money to finance the deficit.

Example

To illustrate, imagine a government that collects USD 100 million in taxes but spends USD 120 million in a year. The difference of USD 20 million creates a budget deficit, which the government will have to finance. The most common method would be to issue bonds or borrow money from a central bank. These actions will incur interest, which the government will have to pay back, leading to an increase in overall debt.

Many countries have engaged in deficit spending to finance large-scale public projects such as highways, public housing or even to overcome times of economic crisis. In the US, for instance, the Federal Reserve has used this method to finance wars and spur economic development during times of recession.

Why Deficit Spending Matters

Deficit spending has both its advantages and disadvantages. On the one hand, it can finance the development of public infrastructure like roads, bridges, schools, and hospitals, leading to an increase in economic growth and job creation.

On the other hand, deficit spending increases the government’s debt, which incurs interest and the need for future taxes. In extreme cases, this can lead to inflation or a decrease in the value of the currency. As a result, this type of spending needs to be used strategically and transparently to maintain economic stability and avoid potential financial crises.