Federal Government Budget as a Share of GNP

EDEIIAL budget deficits of $200 billion or more have created considerable controversy and confusion among analysts, policvrnakers and voters. The important problem, of course, concerns the consequences of current and projected spending, receipts and deficits. Public concern about these problems began, however, with the ballooning of deficits in 1982 and 1983. Many analysts conjecture that recent and projected large deficits have deleterious effects on the economy — raising interest rates, exchange rates, the inflation rate, crowding out private sector investment and economic growth and threatening the economic recovery. Others are more sanguine, arguing instead that recent deficits have not significantly affected interest rates, exchange rates or price behavior. 1 The purpose of this article is to assess these contrasting views on the causes and consequences of recent and prospective deficits. Most of the controversy arises from differences in theoretical and empirical judgments about the effects of deficits on the demand for goods and services. After examining these relevant conceptual issues, recent trends in the federal budget are taken up. Then these conceptual distinctions are used to clarity the source and potential economic effects of recent and projected deficits. In the view of many analysts, both current deficits and future projections indicate a major break with the U.S. postwar experience. It is suggested below that this view is unwarranted when applied to recent deficits. While recent deficits have been large compared with earlier ones, they have arisen largely from the unusual cyclical experience in the U.S. economy, not fi'om unprecedented fiscal policy actions that raised spending and!or reduced tax receipts. Future deficits, however, may represent a majorbreak from the current and past experience. if so, past relationships between deficits and economic performance may prove to be of little use in judging their likely effects. The federal budget deficit is the excess of federal government expenditures over receipts. In analyzing the sources of the deficit and its effect on the economy, it is necessary to distinguish between " active " and passive " components of the deficit. Spending, taxes arid, therefore, the actual deficit are affected by both direct policy actions and changes in the level of economic activity, prices and interest rates. The latter changes occur passively, that is, without fiscal policy actions. Active deficits, in contrast, are those that arise fi'om legislated changes in spending or taxes, given the other economic conditions that influence the deficit. One attempt to deal …