Tolerable limit (or ‘crucial’ limit) of deficit spending is indicative of that stage beyond which its ill-effects overshadow its benefits. ‘The acceptable or tolerable limit of deficit spending is not any absolute figure but a level related to economic conditions of the country.
Such a level is very difficult to estimate, though it is easy to see when the deficit is sufficiently within ‘sale’ limits or clearly exceeding ‘tolerable’ limits, further, the ‘safe’ limit depends upon the way in which a deficit is financed, for example, over-reliance on domestic private borrowings is likely to push up interest rates and ‘crowd out’ private investment.
Similarly, excessive borrowing from abroad is bound to create problems of debt servicing. These problems would be aggravated as the extent borrowings are short-term and/or do not leads to additional export earnings. Debt servicing can become an important factor in accelerating the depletion of foreign exchange reserves.
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In the same way an economy can absorb only a certain amount of additional money without feeding inflation, but an excessive reliance on this source of financing a deficit would he pro- inflationary. The real purchasing power of money balances declines. And the same happens with real rate of interest also.
The burden of outstanding government debt declines and an increase in nominal interest rate seldom compensates for it. Another ill-effect of inflation caused by deficit spending is its impact on income distribution which shifts in favour of non-fixed residuals like profits.
Current thinking supports the thesis that inflation is mainly caused by deficit spending and can be cured only through budgetary reforms. Also deficit spending is a self feeding process. With price rise government expenditure rises faster than its revenue and the government is forced to resort to bigger deficits.
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Deficits cannot be sustained on a prolonged basis without damaging the economy. We have already noted some of these damaging effects like inflation, growing inequalities, and so on.