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What Is Deficit Financing?

A homeowner might use deficit financing to improve his house and increase its value.
Government deficit financing can boost employment rates because it creates increased demand for products and services.
A company might use deficit financing to modernize a factory and thus produce more and better goods.
John Maynard Keynes.
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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 06 November 2014
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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.

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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.

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anon358200
Post 5

@FernValley: You don't know what you're talking about. A tax cut is a cut in the tax rate. This leads to more tax revenue, not less. And deficit financing means spending more than you have (expenditures > revenues). What the government spends, it takes from the private sector. That's why more spending and higher tax rates are bad things for an economy. Don't believe the socialist lies. Government always destroys value and makes us poorer.

anon278071
Post 4

I found the article very useful and at the same time simple to understand.

BambooForest
Post 3

@FernValley, the video The Story of Stuff, at storyofstuff.com, talks a lot about this. It's like when September 11th happened and Bush told America to shop- we have become a nation whose aim is to create consumer goods.

Of course, the problem, besides our own lack of money, is that we survive on a linear system that cannot be maintain, and meanwhile we are destroying the natural resources and monetary systems of many other countries. There are many more economic factors in play beyond just our fiscal deficit, though you would think that would be enough for people.

FernValley
Post 2

Deficit financing has gotten the United States into a lot of trouble. While the deficit grows, people keep thinking things like tax cuts will actually help. While yes, it allows people to have more stuff, it really does not improve quality of life in the long term, and in the end we all just have too many material possessions and not enough sense or savings.

anon82724
Post 1

Nice article. Easy to understand.

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