What is Deficit Financing?

Deficit financing is an approach to money management that involves spending more money than is collected during the same period. Sometimes referred to as a budget deficit, this strategy is employed by corporations and small businesses, governments at just about every level, and even household budgets. When used properly, this financing method helps to launch a chain of events that ultimately enhances the financial condition rather than simply creating debt that may or may not be repaid.

One of the more common examples of government deficit financing has to do with stimulating the economy of a nation in order to bring an end to a period of recession. By establishing a specific plan of action that involves using borrowed resources to make purchases, the government can increase the demand for output from various sectors of the business community. This in turn motivates businesses to hire additional employees, reversing the usual trend of higher unemployment that takes place during a recession. At the same time, the renewed vigor in the marketplace helps to restore consumer confidence, making it more likely for consumers to buy more goods and services. When monitored closely, a carefully crafted plan will restore a measure of stability to the national economy over a period of months or years.

The concept of deficit spending in economics is not limited to government use. Businesses of all sizes may choose to spend more money up front in hopes of generating funds to pay off the investment at a later date. For example, a manufacturer may choose to purchase new machinery for a factory, with the understanding that the newer equipment will allow the business to produce more units of goods in less time, and possibly at a lower unit cost. Over time, the benefits derived from this strategy pay off the accumulated debt and allow the business owners to enjoy a budget surplus rather than a budget deficit.

Household budgets also engage in this form of money management, although the role of deficit financing on an individual level takes a slightly different form than with businesses and governments. An individual may choose to purchase items now with an eye to improving the home in some manner that ultimately increases the value of the property. The accumulated debt is eventually paid in full, leaving the homeowner with an asset that has a higher fair market value than it would without the enhancements. While the ultimate reward is realized when the property is sold at a higher profit, homeowners and their families do get to enjoy the enhanced amenities of the home in the interim.

The idea of deficit financing in economic development is not new. Economists from John Maynard Keynes up to the present day have recognized this strategy, its benefits, and its possible liabilities if not applied properly. While not automatically the best option to correct an undesirable financial situation, its responsible use can ultimately improve the quality of life and the financial status of everyone concerned.