Why are budget deficits good for.the government when there is recession?


Why are budget deficits good for.the government when there is recession?

In: Economics

In a recession, the private sector (businesses, individuals) doesn’t spend money… businesses reduce payroll, defer capital investments in new equipment, factories and such. Individuals tighten their belts either because they’ve lost their job or fear they could. The best way to get the economy into recovery is thus for the government to spend money. It can create demand for businesses’ products and services (building highways and upgrading computers, for example), can create programs to incentivize consumer spending (Bush’s post-9/11 tax rebate checks, Cash for Clunkers). There are also greater demands on unemployment, food stamp, etc. programs. But these all cost money, and in recession the government is collecting less tax revenue while it needs to spend more money. And that means deficit spending.

Its not so much the budget deficit that’s good. Its the increased spending, or lack of cuts in spending, that is beneficial. During a recession, economic activity, by definition, is dropping. To help offset this drop and mitigate it, the government can continuing spending at existing levels or increase spending to make up some of the drop in the private sector. This could mean that unemployment and wages don’t drop as much during a recession, helping to reduce the impact of people and shorten the length of the recession.

If the government had to maintain a balance budget each year, during a recession, the drop in tax revenue would mean that the government spending would also drop. This creates a small feedback loop. Economy drops, so tax revenue drops, so government spending drops, so the economy drops a bit more, lowering tax revenue a bit more, reducing government spending a bit more. Running a deficit helps stop this feedback loop faster.