Possible Macroeconomic Consequences of Large Future Federal Government Deficits

Ray Fair ()

No 1727, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: This paper uses a multicountry macroeconometric model to analyze possible macroeconomic consequences of large future U.S. federal government deficits. The analysis has the advantage of accounting for the endogeneity of the deficit. In the baseline run, which assumes no large tax increases or spending cuts and no bad dollar and stock market shocks, the debt/GDP ratio rises substantially through 2020. The estimates from this run are in line with other estimates. Various experiments off the baseline run are then done. If the dollar depreciates, inflation increases but the effect on the debt/GDP ratio is modest. It does not appear that the United States can inflate its way out of its debt problem. If U.S. stock prices fall, this makes matters worse since output is lower because of a negative wealth effect. Personal tax increases or transfer payment decreases of three percent of nominal GDP solve the debt problem, at a cost of a real output loss of about 1.6 percent over the next decade. The Fed's ability to offset these losses is modest according to the model. Introducing a national sales tax is more contractionary than is increasing personal income taxes or decreasing transfer payments.

Keywords: Federal deficit; Federal debt (search for similar items in EconPapers)
JEL-codes: E17 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2009-09, Revised 2010-02
New Economics Papers: this item is included in nep-cba and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Published in Jeffrey Brown (ed.), Tax Policy and the Economy, Vol. 25, University of Chicago Press, 2010, Ch. 4

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Chapter: Possible Macroeconomic Consequences of Large Future Federal Government Deficits (2010)
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