What is Deficit Financing?

Published by Thomas Herold in Banking, Corporate Finance, Investments

'Deficit Financing' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Deficit Financing refers to a particular emphasis in money management. In this unique angle on financing, companies or governments happily spend a greater amount of money than they take in over the comparable period. This is also called a budget deficit strategy. In fact governments on most levels, small businesses to corporations, and individuals with their household budgets all attempt to engage in this form of financing whenever they can. If it is used carefully and constructively, such a means of financing can create conditions which improve the financial condition of the entity along with the creation of debt that comes alongside it. Such debt might or might not ever be repaid.

Governments take the lead role in such Deficit Financing. Among the more commonplace examples of this is attempting to stimulate the national economy to end recessions. To do this, governments will borrow resources and use the funds to purchase things. This will directly boost the demand for output from businesses sectors, who will in turn hire workers to keep pace with growing government demand. It lowers unemployment and provides salaries to employees who will also increase their spending apace.

This creates a money multiplier effect within the economy. As the marketplace strengthens, consumer confidence will also typically rise, helping still other consumers to save less out of fear and purchase more out of increasing optimism about economic prospects. This leads to a greater quantity of goods and services being purchased by the consumer sector. When properly followed, such a deficit spending plan will actually increase the economic prosperity of a given national economy throughout a period from several months to even a few years in length.

Deficit Financing in the science of economics is not merely restricted to the government though. All sizes and types of businesses may attempt to spend more money than they can practically afford upfront in an effort to generate plenty of funds down the road to pay back the investment when it comes due.

Consider a concrete example. A manufacturing company might elect to buy new factory plants or machinery. They realize that the updated equipment and greater production line space will allow them to produce more goods in a shorter time frame and at a more advantageous cost per unit produced. Given enough time, such advantages of using the strategy will allow them to pay down the upfront debt and maintain a surplus to corporate cash flow and retained earnings.

Consumers similarly attempt to do this with their money management tools. Deficit financing for them means that the individuals will buy things now to improve their house in an effort to boost the value of their real estate. The debt would be then paid back and the owner would keep the higher fair market value home. When the homeowner sells the house, he or she will realize a greater price than before the improvements were made using the Deficit Financing. In the meanwhile, the occupants of the home have the pleasure of enjoying the upgraded facilities, appliances, and amenities that have improved the home value over the long run.

Economic theory and development has held with the idea of Deficit Financing for a long time now. John Maynard Keynes is credited with coming up with the full articulation of the idea in economics. Many economists since him have appreciated the strategy, its advantages, and the dangers if it is not carefully orchestrated. Deficit financing and spending is not necessarily the best means of righting a poor and deteriorating financial situation for an economy, business balance sheet, or household budget. Yet responsibly deploying it may boost the financial status of the country, business, and quality of life of the individuals involved.

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The term 'Deficit Financing' is included in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.