Controversy Over the Federal Budget Deficit: A Theoretical Perspective

14 Pages Posted: 23 Oct 2012

See all articles by Michael Dotsey

Michael Dotsey

Federal Reserve Bank of Philadelphia

Date Written: 1985

Abstract

Recently, the Office of Management and Budget projected that the fiscal 1985 federal budget deficit would exceed $200 billion and that out-year reductions would be gradual at best. These prospects have engendered a debate concerning the economic effects of government deficits and the attendant high level of government borrowing. In this article, Michael Dotsey investigates this topic theoretically using alternative macroeconomic models.

Dotsey first examines a standard Keynesian model and finds that its prediction of a depressing future effect of government borrowing stems from its unrealistic view of the determinants of consumption. He then discusses the Ricardian equivalence idea that the economic effects are the same whether the government finances its expenditures by taxation or by borrowing. His discussion includes an evaluation of several objections that have been raised against Ricardian equivalence. Dotsey also suggests that one must estimate the optimal size of the government deficit as a necessary first step in evaluating current deficit levels.

Suggested Citation

Dotsey, Michael, Controversy Over the Federal Budget Deficit: A Theoretical Perspective (1985). Economic Review, vol. 71, no. 5, September/October 1985, pp. 3-16, Available at SSRN: https://ssrn.com/abstract=2118881

Michael Dotsey (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States
804-697-8201 (Phone)
804-697-8255 (Fax)

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