Eliminating the Federal Budget Deficit Without Recession

Abstract

The federal government's budget deficit of more than $150 billion, some 3 to 4 percent of gross national product, is widely perceived as a serious problem. This article considers policy for wiping out the deficit without recession. Simulations of the Wharton econometric model show that a tax increase would have some slowing effect on the economy but would not cause a recession. Recognition of the possibilities for monetary stimulus, once the deficit is in hand, suggests that the domestic budget deficit can be eliminated without causing an economic slowdown. On the other hand, fixing the domestic budget deficit does not automatically deal with international trade imbalance, which will require other policies and/or international policy coordination in order to be corrected.

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References

the supply-siders by Paul Craig Roberts , The Supply Side Revolution (Cambridge, MA: Harvard University Press, 1984).

2. The corporate sector also plays an important role in providing gross savings flows, representing 12.3 percent of GNP in 1987. The vast bulk of this represents allowances for depreciation. Foreign capital inflows amounted to 3.1 percent of GNP.

3. For a detailed discussion of the theoretical impact of the deficit, see any macroeconomics textbook, for example, R. E. Hall and J. B. Taylor , Macroeconomics, 2d ed. (New York: Norton, 1988).

4. “The finding that countries' investment rates are highly connected with their national saving rates has been confirmed by many studies.” Michael Dooley , Jeffrey Frankel , and Donald J. Mathieson , “What Do Saving-Investment Correlations Tell Us?” IMF Staff Papers, 34(3):503 (1987).

5. Edward F. Denison , Trends in American Economic Growth, 1929-1982 (Washington, DC: Brookings Institution, 1985).

6. Nicholas Brady, chairman of the Brady Commission , has suggested that “the real trigger was that the Japanese...sold an enormous amount of U.S. government bonds.” Wall Street Journal, 22 Apr. 1988.

7. For discussion of model applications for forecasting and simulation, see F. Gerard Adams , The Business Forecasting Revolution (New York: Oxford University Press, 1986).

F. Gerard Adams and Lawrence R. Klein , “Performance of Quarterly Econometric Models of the United States: A New Round of Model Comparisons” (Paper prepared for the Model Comparison Seminar, Washington, DC, 1988).

9. For a discussion, see D. A. Kendrick , Feedback: A New Framework for Macroeconomic Policy (Boston: Kluwer Academic, 1988).

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10. The base forecast and the policy simulations were done using the WEFA Group's Wharton model. The work was done at the University of Pennsylvania, and the author is solely responsible for the results.

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11. The remaining federal deficit is offset by the surplus of state and local governments.