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"Possible Macroeconomic Consequences of Large Future Federal
Government Deficits"
October 2009.
pdf file (65 KB).
Abstract
This paper uses a macroeconometric model of the U.S. economy to
analyze possible macroeconomic consequences of large future
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 deficit
problem. If in addition U.S. stock prices fall, this makes matters worse
by lowering output because of a negative wealth effect.
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.
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