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What Is Deficit Spending and How It Is Supposed to Work

What Is Deficit Spending? Here's An Easy Explanation

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When a business borrows money to expand, we don’t call it deficit spending. When a developer borrows money to build a new shopping center, we don’t call it deficit spending. When a manufacturer borrows money to buy raw materials to make their products, we don’t call it deficit spending. When the government borrows money to rebuild the American economy, we call it… deficit spending.

When a business borrows money to expand, they have to have a plan in place to make a profit and repay that debt. When the government borrows money (deficit spending) to stimulate the economy, they too must have a plan.

In Obama’s press conference on March 24, 2009, he discusses this in a different manner.

He talks about what needs to happen for that deficit to be repaid. He discusses the GDP growth rate that is required and says the following:

"Where the dispute comes in is what happens in a whole bunch of out-years. And the main difference between the budget that we presented and the budget that came out of the Congressional Budget Office is assumptions about growth.

They're assuming a growth rate of 2.2 percent; we're assuming a growth rate of 2.6 percent. Those small differences end up adding up to a lot of money."

What he is talking about is the same process a business goes through in determining if they should borrow money to expand. A business will create a projection based on assumptions about what they think is going to happen. The bank will review those projections and decide if they are willing to lend the business the money.

When you are talking about trillions of dollars, a difference in a .40% growth rate has a huge impact on how quickly the debt will or will not be repaid.

Will it work? We don’t know. Just as a business takes a calculated risk when they borrow, so the government is taking a calculated risk with the expectation that future growth will occur. They think if they fail to act, the economy will deteriorate even further, leading to a long and drawn out recovery. As much as I hate an expanded federal balance sheet, in this case, I think they are right.

As one leading investment firm, Rochdale, stated in their March 2009 analysis:

"Despite our distaste for government intervention, the alternative of leaving the free markets alone would most likely lead to a materially less favorable economic future. We would have taken different approaches, but there was an overwhelming case to be made that action was necessary. The losses facing the banking industries are simply insurmountable without intervention, and failing to act would have increased the severity of the recession."
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