How money enters the economy through deficit spending

Guest post:  From reader McWop who has been a constant for a number of years, aka Matthew McOsker, writes on:

How money enters the economy through deficit spending. A simple model for discussion.


When the government deficit spends here are the mechanics:

a) Government buys goods from some private entity, let’s say $1,000 worth. The government deficit spends to do this. They credit the private entity’s checking account to the tune of $1,000 (increases reserves by $1,000)

b) Government issues a bond for $1,000

c) Private entity’s checking account is debited $1,000 to buy…

On net, a financial asset of $1,000 has been added to the economy – the original reserves are still there!
In this spreadsheet I have created three scenarios, for the sake of discussion. Don’t worry where the initial $1,000 for each person comes from, do not consider one rich or one poor – this is for illustrative purposes only to see the mechanics. There is no foreign trade, nor any private borrowing. That is for another discussion. Treat each year as a a calendar year.

Example 1, the government runs a surplus, and makes zero purchases. Quite simply the surpluses drain the economy and essentially drive the private sector into debt. The government does not save surpluses in any account for a rainy day. Its a drain.

For Example 2, we add in government purchases which slows the drain.

In Example 3, we deficit spend, which adds money to the economy – there is more there to drive aggregate demand.

Deficit spending is our savings, it is NOT like a household budget.

Link to spreadsheet:

https://docs.google.com/spreadsheet/pub?key=0AqGNMQMNwA0tdFNRX3N0MDJhN0o1eFBVTEswc1k4MVE&single=true&gid=0&output=html

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