Robust Fiscal Stabilization

Alan J. Auerbach and Danny Yagan
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Alan J. Auerbach: University of California, Berkeley
Danny Yagan: University of California, Berkeley

Brookings Papers on Economic Activity, 2024, vol. 55, issue 2 (Fall), 239-322

Abstract: Any fiscal path is sustainable if future fiscal policy responds sufficiently to high deficits. Previous work found that Congress reduced the deficit during 1984-2003 when projected deficits rose. We find that this year-to-year feedback has disappeared: Congress on average during 2004-2024 did not respond to the projected deficit. We quantify how strong fiscal feedback needs to be going forward in order to keep the debt-to-GDP ratio below 250 percent in one hundred years, taking as given the debt sensitivity of interest rates implicit in official projections. Without fiscal risk, the government can succeed either by modestly and gradually reducing the deficit or by suddenly and permanently reducing the deficit once this century by 1.5 percent of GDP. When considering large transitory deficit shocks like the COVID-19 pandemic and persistent interest rate shocks, keeping the debt ratio below 250 percent with 95 percent probability requires stronger gradual feedback - 0.5-1.1 percent of GDP average deficit reduction in the next decade - though less strong than actually observed during 1984-2003. Successful sudden feedback requires being able to undertake 1.5 percent of GDP deficit reductions twice in thirteen-year periods, suggesting that a "wait-and-see" approach to successful deficit reduction sometimes allows little waiting.

Keywords: Fiscal policy; Congress; debt and deficits; policymaking (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:bin:bpeajo:v:55:y:2024:i:2024-02:p:239-322

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