Fiscal Deficit Reduction: An Evaluation of Alternatives

In this paper we consider a number of alternative policies aimed at reducing the U.S. fiscal deficit over the course of the 1990s. We offer a quantitative evaluation of these policies that incorporates a number of usually overlooked aspects. One is the role of forward looking asset markets in the adjustment to a credible deficit reduction package. The second is the international impacts ofthe policy and how these spill overs effect the outcome in the United States through changes in exchange rates, trade and capital flows. Third, we explicitly deal with the supply side implications of the alternative proposals as well as the conventional effects on aggregate demand. As a starting point, we consider the Clinton program as announced in February 1993. We find that this program is a credible deficit reduction strategy which should have a short run stimulative effect on the economy in 1993 but during 1994and 1995 the program will tend to slow economic growth unless accompanied by some accommodating monetary policy by the Federal Reserve. Sustained benefits to the U.S. economy emerge by 1998.