Note: I am not an economist. However, I am a recent business management graduate with several econ courses under my belt. Most of what I talk about is taken from those classes.
The circulation of money is, of course, one major mover of the overall economy. This should be obvious. People stashing their wealth under the mattress are, in effect, removing that cash from society for a time. People spending more and more of their wealth, or even just putting money into a bank account, are spreading cash around to be invested over and over into new ventures. Growth is sustained, wheels turn, projects blossom. All of this is, of course, the ideal situation. In this thought experiment, the worst thing that could happen to the economy is a large portion of the population losing faith in everything but the old jar under the bed trick.
Government taxing and spending? Well it rather depends on where the money is going. From a purely short- to medium-term economic perspective, not considering the moral ramifications, foreign aid is burning money for the USA. Consider a shipment of grain to, say, Darfur. Will the food given to refugees entice those same people to spend capital that would otherwise have gone to buying a meal? Perhaps. Will it be very much? No. Will we in the US see even a decent margin of that spending? No.
On the flipside, welfare checks sent to U.S. citizens would, at least to my semi-trained eye, go right back into the system. They get cashed, they get spent almost immediately. Most of the people receiving these checks don’t really have an option to withhold some portion for any length of time. If they want to eat, get clothed, pay the rent… the money gets spent almost before it even arrives.
However, there is a fundamental difference between government spending and government deficit. When a country acquires a deficit, usually through the issuing of bonds to private citizens, it is then locked in to pay interest on each bond issued until it comes due. At that point, the bond’s original value is repaid. All very neat and tidy, as the government is essentially borrowing from its own society. The trouble comes in on two fronts and they can get kinda complicated, so bear with me.
First, the government drawing in money through bonds means that less capital is around for banks and large corporations to acquire. Joe Blow has given his money to the government, not to U.S. Bank. This means U.S. Bank needs to offer more interest on its accounts to attract people from government bonds. It then follows that U.S. Bank, in order to pay the increased costs on interest, must charge more on the money it loans out. This means Smith, Inc. ends up getting charged 20% interest on the loan it wants to take out to expand its plant. Smith, Inc. is suddenly left wondering whether it can even afford to expand that plant anymore. Is it profitable with interest rates being what they are? Maybe the CEO decides to postpone that til next year.
The second piece is much simpler: the more deficit the government racks up, the more money goes to simply paying out interest on its bonds. This means more bonds are issued, with a large deficit being built up and less money to go around. At some point, an approximate upper limit is reached to money raised through bonds. After that, simply servicing the debt takes up money that may have gone to programs that more immediately affect the economy. Worst case scenario? The government is spending all the money paying interest out. However, even in the best case scenario, what money trickles back to Joe Blow investor via interest is probably socked away rather than spent immediately. To Joe, it’s an investment for the future. Will it eventually circulate back to the economy? Of course. Especially if he puts the interest into his savings account. Will it have as much effect as spending the larger amount he used to purchase a bond? Not for a while.
Make any sense? Anyone wanna correct my lessons? I’ll admit I fell asleep from time to time in my morning classes.