The Definition of a Deficit and Its Impact on Economics
Most of the developed world faces deficits, but what is a deficit? Individuals, companies, and governments can incur deficits but face different economic impacts. Individual or personal deficits are always a negative development, while companies may rely on temporary deficits as part of their business strategy.
Most governments today have deficits, as they follow the Keynesian economic model rather than considering Hayek. Therefore, the opinion on government deficits depends on the individual ideology and economic theory. While they can offer short-term positive impacts, governments have shown that since World War II, they have been unable or unwilling to implement responsible fiscal policy, as explained below.
We will provide the a definition of deficit economics, cover the types of deficits, and how they impact individuals, companies, and governments.
What Is the Meaning of a Deficit?
A deficit is a financial term meaning one metric is higher than the base metric, causing a shortfall over a specific period, usually a quarter or a year.
Here are some examples of a deficit:
- Expenses exceed revenues
- Liabilities exceed assets
- Imports exceed exports
The term budget deficit usually applies to governments, and the definition of budget deficit economics is where government spending exceeds government income. While the Keynesian economic model instructs government spending during recessions to avoid a negative cascading effect, it calls for a deficit reversal during economic expansion.
Most governments favor spending more than they receive, depressing government revenues by lowering taxes, and counterproductive and uncompetitive policy and regulation. Since four-year terms for governments result in short-term thinking to secure votes for the next election, deficits became the norm. The US is a prime example of a broker system, heavily debated but never addressed.
Accumulated government deficits result in surging national debt, as governments print money to cover budget shortfalls, applying an ultra-short-term fix to a long-term problem. A prolonged cycle results in inflation, hyperinflation, and stagflation, like what the global economy currently faces.
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What Causes Economic Deficits?
Understanding the causes of economic deficits allows decision-makers to address them, but while they remain well-debated, little to no action is taken, as evident by accumulated deficits and surging debt levels.
Causes of Economic Deficits
- Politics remains the primary reason, as it presents the easiest short-term fix and is popular with voters, who primarily care about stimulus and government-funded institutions, pointing to deeper structural economic issues that can primarily impact the middle class
- Keynesian fiscal deficits, which favor government spending during recessionary periods based on the hope they stimulate future growth, depress the private sector of capital, as governments borrow and spend instead of businesses. This is the favored approach of socialistic economic models
- Economic inefficiencies and structural issues confirm the absence of long-term planning and unsustainable policies, and are driven by a short-term political election cycle
- Cyclical downturns and recessions lower income while expenses remain constant or increase, prompting governments to increase borrowing and accelerate the downward spiral
- Interest payments on accumulated debt result from running continuous deficits
- Production deficits stem from a lack of competitiveness, often directly related to government policies
What Is the Economic Impact of a Deficit?
Keynesian economic models, as practiced by the developed world, have proven that governments should rethink their approach. Alternatives are the heterodox Austrian School founded by Carl Menger and championed by Friedrich Hayek, classical liberalism, and tax reforms outlined by Henry George provide a controversial alternative. No government uses them, as they would result in unpopular changes to existing models, but avoiding changes will magnify current issues.
Economic problems since the global financial crisis and the Great Recession of 2009 resulted in a potentially dangerous new economic approach, the modern money theory (MMT), which calls for eliminating budget ceilings, uncontrolled money printing, and government spending.
Some of the Most Notable Economic Impacts of Deficits
- Unsustainable debt levels and higher interest rate payments
- Dependencies on foreign governments for capital and resources
- Low economic growth rates
- Capital outflows to fiscally stable economic systems amid currency devaluation
- Less available capital for the private sector to spur necessary economic activity
- Economic inequality and inefficiencies, resulting in social unrest
- Erosion of the middle class
- Decrease in the quality of life
- Elimination of free markets
- Government-funded and controlled economic activities
- Debt-driven consumerism
Government Deficit Types Explained
Governments face two primary deficit types, a budget deficit, and a trade deficit. The former poses the most significant economic risk, while the latter is unavoidable to many governments.
What Is a Budget Deficit?
A budget deficit refers to spending exceeding revenues, as practiced by most governments today. Unless governments reign in budget deficits, economic hardship is all but guaranteed.
What Is a Trade Deficit?
A trade deficit occurs when imports exceed exports. Given the availability of resources, some governments have little choice but to run a trade deficit, as it is the only means to acquire necessary resources. Some economists consider exporting countries as stronger than importing countries. China and Germany are examples of export powerhouses, while the US ranks as the biggest importer.
A Definition of Government Deficit Drawbacks
Governments facing a deficit usually face a gradual decrease in financial and economic conditions until they cannot control spending anymore. Attempts to increase revenues, usually via tax increases, generally have the opposite effect.
Besides the economic impacts of deficits outlined above, governments also seek ways to finance spending. The deficit financing definition notes that a government either mints additional capital, which has a negative long-term impact or borrows funds by issuing government securities, raising debt levels, resulting in rising financial costs, and adding to the long-term deficit.
What Is the Difference between a Deficit and Debt?
A deficit is a shortfall, which generally results in increased debt levels. Debt is borrowing money to cover a deficit.
Both have a close relationship:
- A deficit causes debt, while debt can fuel a deficit
- Governments often have no control over deficits, while debt is by choice
- A debt may cover a deficit that was a byproduct of economic conditions or outside factors
- Both are signs of economic weakness and warning signs that existing policies must change to avoid more massive hardship
Is There a Difference between Good Deficits and Bad Deficits?
Some conditions exist where debt fulfills a beneficial purpose. For example, a private company investing in future growth, sending ripple effects throughout the economy, or a government importing necessary resources it cannot obtain otherwise while exporting less due to a production deficit.
Otherwise, deficits are bad, particularly if they continue as long-running shortfalls, leading to massive debt levels and out-of-control spending.
Deficit Conclusion
A deficit is a shortfall between two metrics. For example, expenses exceed revenues, or imports are higher than exports. While isolated short-term circumstances exist where a deficit provides a beneficial economic impact, they are long-term negative contributors. Many governments have proven their inability to use deficit spending responsibly, relying on debt-drive consumerism and unchecked spending to create short-term economic boosts while ignoring the catastrophic long-term impacts.
Individuals must know the deficit definition to understand their devastating effects on balance sheets, which allows for necessary changes to address any shortfalls. Unchecked deficits result in economic hardship, inequality, dependency, inflation, and broad-based deterioration of wealth and living standards.
FAQs
When is a deficit good?
The answer depends on the individual and their preferred economic theory. Some consider a trade deficit good if it provides the government with necessary resources they cannot obtain otherwise. A company can purposefully operate with a deficit as part of a business expansion cycle to increase its market share with a detailed plan to eliminate it over time. Proponents of government deficits during recessions will outline the short-term positive impact, ignoring the long-term negatives.
What does a deficit mean for individuals?
A deficit for individuals means that they spend more than they earn. For example, someone earning $1,800 monthly while spending $2,300 faces a $500 deficit. It is a warning sign and an unsustainable path, as it depletes savings, and individuals must address them quickly to avoid severe economic deterioration.
Why do economists care about deficits?
Deficits illustrate shortfalls that can result in massive long-term economic issues, particularly if they remain unchecked and allowed to accumulate. For example, the US deficit surged from 35% of GDP before the Great Recession of 2009 to 98% in 2023 and is estimated to reach 181% in 2053. Uncontrolled deficits cause economic instability and inequality, and government reactions and inaction can magnify the long-term negative impacts, as evident in the current economic environment.
When does the deficit become a problem?
The deficit becomes a problem if it spirals out of control over a prolonged period. Individuals feel an immediate impact on their balance sheet. Companies have more time to manage their deficits but can also accelerate their path to bankruptcy unless they deliver positive results. Governments have more resources and can print money or raise taxes, which often leads to a spike in inflation and lower revenues. Unchecked trade deficits lead to dependency and potential conflict during disagreements.
Is a deficit always bad?
Keynesian economists will point out that deficits can help an economy during recessions. Modern economic history shows that governments fail to address them during expansions, which has caused an accumulation of long-term issues. A deficit for individuals is always negative, while companies and governments who use a deficit responsibly can face temporary beneficial conditions. Regrettably, developed governments have shown their inability to use deficit responsibly.