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Possible Macroeconomic Consequences of Large Future Federal Government Deficits

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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.

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Bibliographic Info

Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1727.

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Length: 27 pages
Date of creation: Sep 2009
Date of revision: Feb 2010
Publication status: Published in Jeffrey Brown (ed.), Tax Policy and the Economy, Vol. 25, University of Chicago Press, 2010, Ch. 4
Handle: RePEc:cwl:cwldpp:1727

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Keywords: Federal deficit; Federal debt;

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  1. Jordi Galí & Mark Gertler, 2007. "Macroeconomic modeling for monetary policy evaluation," Economics Working Papers 1039, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 2007.
  2. Ray C. Fair, 2007. "Testing Price Equations," Kiel Working Papers 1342, Kiel Institute for the World Economy.
  3. Ray C. Fair, 2009. "Analyzing Macroeconomic Forecastability," Cowles Foundation Discussion Papers 1706, Cowles Foundation for Research in Economics, Yale University, revised Aug 2010.
  4. Fair, Ray C, 2005. "Estimates of the Effectiveness of Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(4), pages 645-60, August.
  5. Ray C. Fair, 2009. "Has Macro Progressed?," Cowles Foundation Discussion Papers 1728, Cowles Foundation for Research in Economics, Yale University, revised Jul 2010.
  6. Ray Fair, 2009. "Analyzing Macroeconomic Forecastability," Yale School of Management Working Papers amz2443, Yale School of Management, revised 01 Oct 2009.
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Cited by:
  1. Ray C. Fair, 2010. "Estimated Macroeconomic Effects of the U.S. Stimulus Bill," Cowles Foundation Discussion Papers 1756, Cowles Foundation for Research in Economics, Yale University.

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