WHAT IT TAKES TO SOLVE THE U.S. GOVERNMENT DEFICIT PROBLEM

Authors

  • RAY C. FAIR

    1. Fair: Cowles Foundation and International Center for Finance, Yale University, New Haven, CT 06520-8281. Phone 203-432-3715, Fax 203-432-6167, E-mail ray.fair@yale.edu
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    • The results in this paper can be duplicated on the author's website (fairmodel.econ.yale.edu), and alternative base runs and experiments can be done. The MCH version is used, dated April 27, 2012. I am indebted to William Brainard for helpful comments.


Abstract

This paper uses a structural multi-country macroeconometric model to estimate the size of the decrease in transfer payments (or tax expenditures) needed to stabilize the U.S. government debt/gross domestic product (GDP) ratio. It takes into account endogenous effects of changes in fiscal policy on the economy and in turn the effect of changes in the economy on the deficit. A base run is first obtained for the 2013:1–2022:4 period in which there are no major changes in U.S. fiscal policy. This results in an ever increasing debt/GDP ratio. Then transfer payments are decreased by an amount sufficient to stabilize the long-run debt/GDP ratio. The results show that transfer payments need to be decreased by 2% of GDP from the base run, which over the 10 years is $3.2 trillion in 2005 dollars and $4.8 trillion in current dollars. The real output loss is 1.1% of baseline GDP. Monetary policy helps keep the loss down, but it is not powerful enough in the model to eliminate all of the loss. The estimates are robust to a base run with less inflation and to one with less expansion. (JEL E17)

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