COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1727 Possible Macroeconomic Consequences of Large Future Federal Government Deficits Ray C. Fair September 2009 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. |
