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Controversy over the federal budget deficit : a theoretical perspective

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  • Michael Dotsey
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    Abstract

    Recently, the Office of Management and Budget projected that the fiscal 1985 federal budget deficit would exceed $200 billion and that out-year reductions would be gradual at best. These prospects have engendered a debate concerning the economic effects of government deficits and the attendant high level of government borrowing. In this article, Michael Dotsey investigates this topic theoretically using alternative macroeconomic models. Dotsey first examines a standard Keynesian model and finds that its prediction of a depressing future effect of government borrowing stems from its unrealistic view of the determinants of consumption. He then discusses the Ricardian equivalence idea that the economic effects are the same whether the government finances its expenditures by taxation or by borrowing. His discussion includes an evaluation of several objections that have been raised against Ricardian equivalence. Dotsey also suggests that one must estimate the optimal size of the government deficit as a necessary first step in evaluating current deficit levels.

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    File URL: http://www.richmondfed.org/publications/research/economic_review/1985/pdf/er710501.pdf
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    Bibliographic Info

    Article provided by Federal Reserve Bank of Richmond in its journal Economic Review.

    Volume (Year): (1985)
    Issue (Month): Sep ()
    Pages: 3-16

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    Handle: RePEc:fip:fedrer:y:1985:i:sep:p:3-16:n:v.71no.5

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    Keywords: Budget deficits;

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    1. Chan, Louis Kuo Chi, 1983. "Uncertainty and the neutrality of government financing policy," Journal of Monetary Economics, Elsevier, vol. 11(3), pages 351-372.
    2. Aschauer, David Alan & Greenwood, Jeremy, 1985. "Macroeconomic effects of fiscal policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 23(1), pages 91-138, January.
    3. Robert B. Barsky & N. Gregory Mankiw & Stephen P. Zeldes, 1987. "Ricardian Consumers With Keynesian Propensities," NBER Working Papers 1400, National Bureau of Economic Research, Inc.
    4. Bryant, John, 1983. "Government Irrelevance Results: A Simple Exposition," American Economic Review, American Economic Association, vol. 73(4), pages 758-61, September.
    5. Drazen, Allan, 1978. "Government Debt, Human Capital, and Bequests in a Life-Cycle Model," Journal of Political Economy, University of Chicago Press, vol. 86(3), pages 505-16, June.
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