Budget deficits occur when a government spends more money than it receives in revenue. If this persists over a long period, it can lead to a buildup of debt and a higher debt ratio to GDP. Let’s look at how this affects the economy as a whole.
Why Deficit Spending is not Optimal
One of the main arguments against budget deficits is that they can lead to inflation, which reduces the purchasing power of money and can lead to a decrease in economic growth. When the government borrows money to finance its deficit, it can lead to an increase in interest rates, which makes it more expensive for businesses to borrow money and invest in new projects. This can result in lower levels of investment and slower economic growth. It is debt that expands the monetary base, which bids up prices because people have more money nominally.
Additionally, persistent budget deficits can also lead to a decrease in private investment as investors become worried about the government’s ability to repay its debt, which can lead to a loss of confidence in the economy. This can result in a decrease in foreign investment and a lower value of the country’s currency, which makes exports more expensive and imports cheaper, leading to a trade deficit.
There is a lot of economic research and data that supports these arguments. For example, a study by economists Carmen Reinhart and Kenneth Rogoff found that when the debt-to-GDP ratio reaches 90% or more, it can lead to slower economic growth. Another study by the International Monetary Fund found that high government debt levels can lead to lower levels of investment and slower economic growth.
What do Economists Say?
Some of the most well-known economists who have argued against budget deficits include Milton Friedman, Paul Krugman, and Joseph Stiglitz. Friedman argued that persistent budget deficits could lead to inflation and a loss of economic confidence, reducing economic growth. Krugman has argued that budget deficits can be necessary for an economic recession. Still, they should be reduced during economic growth to prevent inflation and a loss of confidence. Stiglitz has argued that budget deficits can be bad for the economy if not accompanied by investment in public goods and services that can increase economic growth and productivity.
In conclusion, while budget deficits can be necessary during an economic recession, they can also harm a country’s economy if they persist over a long period. Persistent budget deficits can lead to inflation, higher interest rates, decreased private investment, a trade deficit, and slower economic growth. Much economic research and data support these arguments, and many well-known economists, such as Milton Friedman, Paul Krugman, and Joseph Stiglitz, have argued against budget deficits.
OK, Decificits slow the economy, but what is the solution?
The traditional or classic gold standard can help limit budget deficits by restricting the ability of governments to print money and spend beyond their means. Under a gold standard, the value of a country’s currency is pegged to a specific amount of gold, and the central bank is required to hold a certain amount of gold reserves. This limits the ability of governments to print money and spend beyond their means because they cannot increase the money supply beyond the amount of gold they have in reserve.
However, the gold standard does not entirely prevent budget deficits. Governments can still run budget deficits by borrowing money, and the gold standard does not limit the amount that a government can borrow. In practice, many countries that adhered to the gold standard still experienced persistent budget deficits, although these deficits were generally smaller than in countries without a gold standard.
It’s worth noting that most countries abandoned the gold standard in the 20th century, and there is an ongoing debate among economists about its potential benefits and drawbacks. Some economists argue that the gold standard can help stabilize the economy and prevent excessive inflation. In contrast, others argue that it can restrict economic growth and limit the ability of governments to respond to economic shocks.
What is my opinion on the Gold Standard?
A Gold standard acts as an anchor to the market rate of interest, bringing the monetary economy and the real economy into a macro money equilibrium. It would restrain the expansion of government and be beneficial to the Gini coefficient. I talk a lot about this on my Youtube Channel here: EconLessons.
Austrian Economics and their view
Ludwig von Mises, an Austrian economist and one of the leading proponents of the Austrian School of economics, strongly supported the gold standard. He believed a gold standard was essential for a stable and predictable monetary system. It was necessary to prevent government manipulation of the money supply, which could lead to inflation and other monetary problems.
Mises argued that the gold standard is a self-regulating system that maintains price stability and helps prevent inflation by restricting the ability of governments to create money and spend beyond their means. He believed that the gold standard provides a stable anchor for the monetary system, which promotes long-term economic growth and stability.
Mises also believed that the gold standard helps ensure the freedom and independence of individuals and businesses by preventing governments from manipulating the money supply for their own purposes. He argued that a gold standard promotes economic freedom and checks government power by limiting the ability of governments to engage in monetary experimentation and abuse their powers.
In Mises’ view, the gold standard was the only monetary system that could provide stability and predictability necessary for a market economy to function effectively. He believed that the gold standard was superior to other alternatives, such as fiat currency or paper money and that it was essential for a free and prosperous society.
I can not see any other way to control the debt and the deficit except for free banking or competing currencies. Let me know what you think.