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< Back to question Do deficits matter? Show more Show less

For decades, politicians and economists have condemned deficits as evil. Today, there is a lively debate about whether deficits matter and whether there are advantages to running them. Most notably Modern Monetary Theory encourages the government to run deficits in order to achieve its objectives of full employment and investment.

Structurally high deficits are bad Show more Show less

High deficits that are due to structural (as opposed to temporary cyclical deficits) are bad. They lead to higher inflation and the crowding out of private investment.
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High deficits by central banks cause high inflation

High government spending can be one of the main causes of inflation. Governments spending more than they are making causes the value of currency to diminish.
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The Argument

While inflation and deficits are not the same, they are related. Deficits—when a government spends more than it makes—can cause inflation in various ways. One such way is by the privatization of the government's debt. If a central bank raises interest rates to fund the debt undertaken by a government, it can price out competitors in a given marketplace from getting into the marketplace or expanding their production in that marketplace. This, according to Federal Reserve Bank of Minneapolis Monetary Advisor Preston J. Miller, can lead to inflation. If the same amount of money is competing for fewer products, the cost of those products will go up.[1] In addition, the prices don't even have to rise, but the mere assumption or belief that prices will rise can also cause inflation.[2] In Latin America, countries that have high inflation have three things in common. They had incredibly high deficits, those deficits were funded by the central bank and therefore caused more money to go into circulation, and the governments refused to raise taxes to finance the deficits, and that the taxes don't increase when the price of goods increases.[3] Safe monetary policies can be used in tandem with deficit spending to prevent or slow inflation, but without that, inflation will rise if government deficits rise.

Counter arguments

Deficit spending does not always lead to high inflation. Economist John Maynard Keynes argues that in times of economic downturns for the country (wars, depressions, recessions, etc.) where unemployment is high and spending is low, governments should use deficit spending to boost the economy and prevent further economic turmoil. Deficits can lead to inflation in developing countries, but in the U.S. deficits will only lead to higher taxes for future generations, according to economist Scott Summer.[4]


Rejecting the premises



This page was last edited on Wednesday, 23 Sep 2020 at 20:48 UTC

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