>Talking Point (Deutsche Bank)

Deficit spending: You'd better keep an eye on it, too

Deficit spending can be helpful to overcome the current economic crisis. However, the necessity to stimulate the economy does not justify public spending sprees. Economic stimulus programmes come with a caveat. Strongly increasing public deficits and public debt can weaken major forces of economic growth.

In Germany as well, higher government expenditure is the policy of choice to fend off the economic crisis. Two stimulus packages of EUR 80 bn have already been enacted by the federal government. The spending programmes, which equal roughly 3% of GDP, are contentious. While advocates expect a sustained boost to economic growth, critics fear that the packages will fail to heal the recession.

The programmes are designed to reinvigorate the weak demand for goods and services and prevent a free fall of the economy. The German government and other advocates do not only count on the direct effects of the rise in public spending. They also expect a boost to private-sector consumption and investment activity. Under the optimistic scenario, the measures will not only push up GDP by EUR 80 bn; the actual added value is expected to be higher as the measures will have a positive effect on the business climate. This will keep more employees on the payroll and thus stimulate consumption and investment, it is argued. But economic stimulus programmes come with a caveat. They push up national debt. This is part of the deal, so to speak. If the government now wants to spend more for economic stimulus programmes such as road infrastructure projects and the refurbishment of public buildings, and supports many citizens wishing to buy a new car by implementing the scrapping bonus, it must not, of course, finance these measures by simultaneous tax increases. The only instrument for the government to stimulate demand is debt financing.

To see full report: TALKING POINT