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Heather McGuire

Professor Dennis Wilson


ECON 2020 401
3 December 2015
How War Affects the Macro-economy
War involves in its progress such a train of unforeseen
circumstances that no human wisdom can calculate the end; it has
but one thing certain, and that is to increase taxes. Thomas
Paine
When it comes to war, the economic costs for federal and international economies may be
difficult to measure. However, military spending has increasingly become a focal point of
macroeconomic discussion; therefore, military expenditures have been recorded with a greater
deal of accuracy in more recent decades. Like all government debt, financing for war must be
paid by the economy as a whole through increased taxation and selling government bonds. In
addition to raising the funds to pay the governments increased debt caused by war expenditures,
increased government spending directly impacts the interest rates of consumers in the economy.
Between the increased taxation, increased savings, rising interest rates, and reduced disposable
income that result from governmental war expenses, the largest macroeconomic impact affects
the ability of consumers and business to spend.
Government Expenditures on Military and Defense
Government expenditures on military capital, equipment, labor, and other resources
amounts to a significant portion of the macroeconomic budget. This amount is significantly
higher for the United States government when compared to foreign countries and regions.

According to the Stockholm International Peace Research Institute (SIPRI), United States
expenditures on military capital in 2014 amounted to just under 610 billion U.S. dollars. United
States military expenditures amounted to over 150% of the money spent on military expenditures
in all of Europe in 2014 which was equivalent to approximately 386 billion U.S. dollars (SIPRI).
In times of war or ongoing military operations abroad, government spending on the defense
budget rises. It is estimated by the Center on Budget and Policy Priorities (CBPP) that current
defense spending, by the United States government in 2014, consumes 18% of the national
budget; the only two budget categories greater than defense include Social Security at 24% and
health insurance spending which accounts for another 24% of the budget. It is debated by the
majority of economists as to whether massive government spending on war is a benefit or a
disadvantage (Teslik, 2008).
Opportunity Cost of War
The supply of resources in any economy is not infinite. Therefore, in order to produce
more of one type of a good or service with those limited resources, the economy must forgo the
production of another type of good or service. This scenario is known as the opportunity cost.
Because goods and services cannot be produced without opportunity cost, war shifts the
production of goods and services toward military goods and services as it shifts production away
from civilian goods and services. This shift of which products will be produced illustrates the
macroeconomic opportunity cost created by war.
Taxation and Government Securities
To wage war, you need first of all money; second, you need money, and third, you also
need money (Prince Montecuccoli). Military expenses to finance war become government

debts, and money is required to pay those debts like all other public, private, and government
debts in society. The revenue of the government comes from taxes and selling of government
securities. Debt incurred by the government is paid in part by income taxes received by citizens
of the economic region or country. The remainder of the government debt is financed by selling
government securities to the public through bonds. When government policy increases the
income tax rate, the disposable incomes of the people within the economy are also reduced.
When the government sells securities to the public in the form of bonds, the money to pay for
them comes from the disposable income of consumers and businesses. Both scenarios impact the
spending ability of individuals, households, firms, and businesses. It also calls in to question
whether the overall money supply and resources of the economy are being allocated in the most
efficient way.
Increased Government Spending and Interest Rates
According to the lecture Effectiveness of Monetary and Fiscal Policies at Iowa State
University, An increase in government spending shifts the IS [Investment Savings] curve to the
right. As a result, domestic interest rate rises. This asserts that increasing government
expenditures in times of war can affect the ability of civilian consumers to obtain financing
because they must pay a higher amount of interest on loans and borrowed money. Additionally,
consumers tend to save more than they spend during times of high interest rates because they can
earn higher rates of return for saving their money for future expenditures. An article How
Interest Rates Affect the U.S. Markets published by Investopedia, a highly reputable investment
information website, concludes that higher interest rates mean that consumers don't have as
much disposable income and must cut back on spending. War increases government spending

which in turn raises the interest rate offered to consumers, firms, and businesses; these rates
reduce the amount of money society is willing and able to spend on civilian goods and services.
Conclusion
Despite the fact that economist cannot agree on whether increased government spending
to fund war is beneficial or harmful to the economy as a whole, the fact remains that any form of
increased government spending deeply affects the ability of consumers and businesses within the
economy to spend, borrow, and obtain goods and services for private consumption. As
government spending increases for war, the money supply shifts toward military and defense
goods, services, and labor, and away from private consumer and business goods and services.
This reduces the ability of both consumers and businesses to invest in new capital because
interest rates have increased, so investments in future capital become more expensive. In
addition, consumers and businesses alike are impacted by rising income tax rates because a
larger portion of their gross income is diverted to pay those taxes. Thus, disposable income is
reduced, and civilian spending falls.

References
Effectiveness of Monetary and Fiscal Policies. (n.d.). Retrieved December 2, 2015, from
http://www2.econ.iastate.edu/classes/econ355/choi/eff.htm
How Interest Rates Affect The U.S. Markets. (2008, November 6). Retrieved December 2, 2015,
from http://www.investopedia.com/articles/stocks/09/how-interest-rates-affectmarkets.asp
Policy Basics: Where Do Our Federal Tax Dollars Go? (2015, March 11). Retrieved December 2,
2015, from http://www.cbpp.org/research/policy-basics-where-do-our-federal-tax-dollarsgo
SIPRI Military Expenditure Database. (2015, November 3). Retrieved December 2, 2015, from
http://www.sipri.org/research/armaments/milex/milex_database/milex_database
Teslik, L. (2008, February 4). Iraq, Afghanistan, and the U.S. Economy. Retrieved December 2,
2015, from http://www.washingtonpost.com/wp-dyn/content/article/2008/02/04/
AR2008020402043.html