Individual Impact of Substantial Government Debt, Part Four: The Economy

To examine what government does to the economy, we must first examine what a large amount of debt does to a corporation.

In many cases, large amounts of debt do nothing significant, as individuals are still confident in the corporation's ability to maintain interest payments over long periods of time. On the other hand, large amounts of debt can also cause panic among investors, driving down stock prices and requiring higher interest rates to secure capital through the use of bonds.

For the government, we would ideally hope that the first case is the one that holds. Largely, it can also be shown that this is the case that holds. However, there is one major difference - deficit spending by the government causes inflation. Here's why.

Deficit spending by the government both reduces overall confidence in the government's finances and, generally, increases the supply of money available to the economy.

Considering that currency can be thought of as the government's version of 'stock,' and inflation is the devaluation of currency, a lack of confidence in government finances obviously increases inflation.

Additionally, increasing the money supply is both theoretically and empirically linked to greater inflation. The Quantity Theory of Money does a great job of explaining why this is the case, but I will leave it to you to Google it and find out more if you so wish.

As such, we can definitely say that government deficit spending will increase inflation when all other things are held constant (HAEC - holding all else constant, is an acronym I'll probably be using in the future). So, HAEC, government deficit spending will increase inflation, although the degree to which it will is not well understood.

To be clear, inflation is not necessarily a bad thing in moderation. To be even more clear, inflation equivalent to the growth rate of the economy can even be considered healthy. As such, this is a negative drawback only when inflation is increased to an unhealthy point as a result of government deficit spending.

Other effects of deficit spending on the economy are largely small and, in many cases, highly dependent on the manner of both the spending and the method of acquiring funds. For instance, the sale of additional government bonds and the general upward trend in the interest rates on those bonds over time as confidence in the government's finances decreases has an impact on the market for bonds.

However, these are all largely small impacts, and we shall ignore them as they have very little impact on the average individual.

Anyways. Apologies for not getting this up over the weekend, but I have been busier than expected. My next post will, hopefully, wrap this topic up quite nicely, but we shall see. If you have any ideas for other topics to discuss or questions or random comments, feel free to leave them.