Possible Macroeconomic Consequences of Large Future Federal Government Deficits

26 Pages Posted: 29 Sep 2009 Last revised: 27 Oct 2009

See all articles by Ray C. Fair

Ray C. Fair

Yale University - Cowles Foundation; Yale School of Management - International Center for Finance

Multiple version iconThere are 2 versions of this paper

Date Written: September 29, 2009

Abstract

This paper uses a macroeconometric model of the U.S. economy to analyze possible macroeconomic consequences of the large future federal government deficits. The analysis has the advantage of accounting for the endogeneity of the deficit. The results are bleak. Assuming no large tax increases or spending cuts and no bad dollar and stock market shocks, the debt/GDP ratio rises substantially through 2020. These estimates are in line with other estimates.

If the dollar depreciates in response to the deficits, 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 deficit problem. If in addition U.S. stock prices fall, this makes matters worse by lowering output. Large personal tax increases or transfer payment decreases solve the deficit problem, but at a cost of considerable lost output over a 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.

Keywords: federal deficit, federal debt

JEL Classification: E17

Suggested Citation

Fair, Ray C., Possible Macroeconomic Consequences of Large Future Federal Government Deficits (September 29, 2009). Yale ICF Working Paper No. 09-22. Available at SSRN: https://ssrn.com/abstract=1480194 or http://dx.doi.org/10.2139/ssrn.1480194

Ray C. Fair (Contact Author)

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States
203-432-3715 (Phone)
203-432-6167 (Fax)

HOME PAGE: http://fairmodel.econ.yale.edu

Yale School of Management - International Center for Finance ( email )

Box 208200
New Haven, CT 06520
United States
203-432-3715 (Phone)
203-432-6167 (Fax)

HOME PAGE: http://fairmodel.econ.yale.edu

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