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Possible Macroeconomic Consequences of Large Future Federal Government Deficits

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  • Ray C. Fair

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 performed. 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 3% of nominal GDP stabilize the debt/GDP ratio, at a cost of a real output loss of about 1.6% 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.

Suggested Citation

  • Ray C. Fair, 2011. "Possible Macroeconomic Consequences of Large Future Federal Government Deficits," Tax Policy and the Economy, University of Chicago Press, vol. 25(1), pages 89-108.
  • Handle: RePEc:ucp:tpolec:doi:10.1086/658382
    DOI: 10.1086/658382
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    References listed on IDEAS

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    1. Jordi Galí & Mark Gertler, 2007. "Macroeconomic Modeling for Monetary Policy Evaluation," Journal of Economic Perspectives, American Economic Association, vol. 21(4), pages 25-46, Fall.
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