ECONOMIC AND BUDGET ISSUES FOR DEFICIT POLICY

Ronald Hoffman and Mickey D. Levy

Contemporary Economic Policy, 1984, vol. 3, issue 1, 96-114

Abstract: Much of the controversy about reducing the federal deficit has arisen because policymakers lack a deficit policy that is a consistent part of broader macroeconomic policy. This is not surprising since economists have not reached a consensus about such a policy. This paper sketches the analytical controversy about monetary and fiscal policies and traces it to issues about how the economy works. Although aspects of the deficit question are controversial, there is general concern about the buildup of federal debt implicit in the projection of persistently large deficits. A growing body of research suggests that the increase in the federal debt‐to‐income ratio may impinge dangerously on the credit available to finance private capital formation. Also, the rising federal debt may indirectly generate inflation through monetization. Several criteria and approaches to a deficit policy are identified. The paper suggests that changing the “policy mix” by tightening fiscal policy and loosening monetary policy to reduce interest rates is unlikely to succeed to the extent that expansive monetary policy increases real interest rates by raising inflationary expectations and uncertainty. Since the potential ill effects of the federal debt buildup, are essentially long‐run and bear on capital accumulation, any tax increases should avoid disincentives to saving, investment, and to growth generally. Depending on revenue requirements, fundamental changes in the tax system may be necessary. Further reductions in spending appear to be inevitable if the projected rise in the debt‐to‐GNP ratio is to be halted. Defense, retirement, and medical care programs are most likely candidates for reduction.

Date: 1984
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