What are the benefits of deficit financing

Deficit spending as an economic stimulus program

Germany has often mastered economic crises in the past. In times of recession, when the economy shrinks and employment levels fall, the state can intervene.

One example was the environmental or scrapping premium that the state paid in 2009 as part of the economic stimulus package II in order to get the new car business going again after the financial crisis.

This does not only affect car buyers, but also employees and investors who are invested in stocks, for example. If the economy is bad, companies increasingly cut jobs in order to save costs. In addition, a recession is usually associated with falling sales and corporate profits, which usually also has a negative effect on share prices.

Deficit Spending - when the state intervenes through higher spending

The state has various options to counteract this. One option is deficit spending, also known as deficit financing. This describes a process when the state goes into debt and places more public contracts (infrastructure projects) through higher spending, for example in order to stimulate the construction industry again. Ultimately, construction companies and listed companies such as HeidelbergCement, Hochtief and Bilfinger benefit from this, which in turn is of interest to investors.

With deficit spending, expenditure naturally exceeds income, which increases the overall budget deficit. The measure is based on the income and employment theory of the economist John Maynard Keynes. This theory calls for additional demand stimuli during a recession through higher spending on the part of the state, which is intended to stimulate the economy again.

The multiplier effect in deficit spending

The activity of the state should de facto trigger a chain reaction. The government contracts are intended to increase the level of employment, which means that more income is available overall for private households. If employees have more income available, more can be consumed again, which benefits economic growth.

Ideally, the higher debt should be reduced again later when the economy recovers. If the economy is booming, the state can usually look forward to higher tax revenues, which leads to budget surpluses. As a result, the state hopes for a balanced budget again later. This process is also known as countercyclical fiscal policy.

How effective is deficit financing in practice?

However, deficit financing has come under increasing criticism. The hoped-for budget surpluses as a result of an economic recovery are often lower than expected or do not materialize at all. This is especially true if the spending level remains consistently high.

The result: the national debt is increasing rapidly, which has become a major problem in many countries. Not only small countries like Greece are affected, but also important economies like the USA. Deficit spending also has another major disadvantage: government demand often pushes private investment projects into the background, which is known as crowding out.

The state is increasingly replacing private investment. Furthermore, the effects of deficit financing cannot be precisely estimated, so that positive effects can only materialize with a delay when the economy is already back in full swing.

Deficit spending is being phased out

Deficit spending is now a discontinued model. The financial and debt crisis has shown the model its limits in recent years. The calls for a lean and thrifty state are getting louder after it has been recognized that the escalating debt policy is primarily a burden for future generations.

Deficit spending often only helps individual sectors such as the construction and automotive industries to get more orders, from which individual companies and their investors benefit. Overall, deficit spending is no longer seen as a panacea for solving economic problems.

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