Further spending becomes detrimental when it engages resources, including manpower, currently in demand by the private sector. But if the private sector is operating below its productive capacity for lack of sufficient purchasing power, additional government spending will be beneficial. Deficit spending adds to the aggregate demand of the private sector. People and business are likely to spend more when they hold government securities, than when all they have is receipts for payment of taxes. But a deficit is a real deficit only to the extent that it adds to the real value of the public s holding of government debt.
Price inflation is effectively a tax on the holders of debt and thus reduces the real deficit.
We do not know how large the national debt can grow before it has a net negative impact on the economy. In relation to national income it has been much higher than it is currently without acting as a drag on the economy. Indeed studies of the historical record show that higher values of real deficit as a percentage of GDP have been associated with more rapid growth in the real output of the economy. An often-heard objection to the national debt is the taxes required to support interest payments to the bond holders. What is generally overlooked is that, in the aggregate, the interest payments are recaptured in taxes, most of it from upper and middle income taxpayers.