Recent academic and popular discussions of budget deficits rely upon a simplistic and, in large part, false conception of their effects. The recent literature ignores the fact that deficit effects depend on their source and on private sector responses to them. It also matters whether budget changes arise passively through the workings of the business cycle and whether deficit-inducing policy actions are permanent or transitory. More often than not, deficits are associated with lower interest rates. One reason is that large movements in budget deficits are principally due to the business cycle. Recessions lower investment and interest rates and also lower capital inflows. The widely popular idea that current account deficits arise from budget deficits is also not correct. Current account movements are related to international capital flows that respond more to incentives for domestic investment than to budgetary developments. Not surprisingly, the key expectations of the simple theory now circulating, especially about interest rates, the current account deficit and the dollar, are precisely opposite to what modern theory and evidence indicate. Investment and asset allocation decisions that rely on the popular misrepresentations of why and how deficits matter do material damage to investor interest.
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number
4118.
Find related papers by JEL classification: H6 - Public Economics - - National Budget, Deficit, and Debt E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents
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