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Do Deficits Matter?

The short answer is “yes.”
The long answer (nicely laid out in a recent Macroeconomics Forum at Brookings) is that it depends on the time horizon.
Here are the basic ideas.
In the long run, persistent deficits can lower national savings and hence investment; thus harming the economy in the future.
In the short run, reducing national savings may be a good idea, if we have an economy that is operating below potential, and if we need some additional current expenditures to get the economy moving again. (*However, see note below.)
Of course the easy question is “does it matter?” – the harder question is “how much?” Unfortunately, this is a fundamentally hard question to answer (since just about everything depends on everything else in the macroeconomy, and we can’t exactly run controlled experiments on economies).
As a result, there is no consensus about the magnitude of the effect of deficits on, for example, interest rates or long-run growth. At most we can say that there is potentially a large and significant effect – it would seem prudent then, at the very least, to limit persistent deficits as much as possible.
For more on the effect of deficits, see the link below. For current and projected deficit numbers, see CBO: The Budget and Economic Outlook: Fiscal Years 2004-2013
*note – The more astute macroeconomists will of course note that Ricardian equivalence provides a theory in which private savings decisions may perfectly counteract the effect of deficits. My view is that Ricardian equivalence, while a nice extreme case, which provides some good intuition as to how the economy potentially works, fails both theoretically and empirically as a guide to policy. I think my view is common among most economists (although I haven’t done an exhaustive poll!)

The Brookings Institution
Controversies over the effects of fiscal policy on the economy have been at the heart of the policy debate surrounding the chronic deficits of the 1980s, the sharp rise in official budget surpluses in the late 1990s, and the equally sharp decline in the fiscal outlook recently.
This panel discussion, the first in an ongoing series on macroeconomic issues sponsored by the Brookings Institution, will examine a variety of questions regarding the effects of deficits on the economy: Do budget deficits matter? Under what circumstances and what time horizons are they good, bad, or neutral? How important are they to strong economic growth?
Following their remarks, panelists will answer questions from the audience.

Filed under: Data, Economics, Economy, Fiscal Policy, Policy, Recession



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