Fiscal Deficits and The Current Account - PowerPoint PPT Presentation

About This Presentation
Title:

Fiscal Deficits and The Current Account

Description:

... budget deficit) reduces national savings and, hence, leads to larger CA deficits. ... affected the CA in the 1980s not because of the budget deficits, but because ... – PowerPoint PPT presentation

Number of Views:94
Avg rating:3.0/5.0
Slides: 19
Provided by: xx15
Category:

less

Transcript and Presenter's Notes

Title: Fiscal Deficits and The Current Account


1
Fiscal Deficits and The Current Account
  • Roberto Chang
  • March 2007

2
Twin Deficits?
  • National Savings Private Savings Government
    Savings
  • Government Savings Budget Surplus
  • So, it is easy to conclude that a reduction in
    the budget surplus (i.e. a larger budget deficit)
    reduces national savings and, hence, leads to
    larger CA deficits.

3
  • The only effective US policy response to the
    CA problemis a conversion of our present (and
    especially prospective) budget deficits into
    modest surpluses a la 1998-2001.
  • C. Fred Bergsten, The Current Account Deficit
    and the US Economy, Testimony before the U.S.
    Senate, Budget Committee, Feb. 1 2007.

4
Problems with the Twin Deficits Argument
  • As we have discussed, the argument implies that
    interest rates would have risen, which has not
    been the case in recent years.
  • It may be more relevant, however, for other
    periods, such as the 1980s.

5
(No Transcript)
6
  • A second problem is that the Twin Deficits
    argument relies on the assumption that private
    savings do not change when fiscal deficits
    increase.
  • This is arguably not always the case.
  • In fact, in theory private savings may completely
    offset changes in the fiscal deficit Ricardian
    Equivalence.

7
Ricardian Equivalence
  • Consider a two period small open endowment
    economy with a government.
  • The representative household has to pay taxes Tt
    taxes in period t 1,2.

8
  • The present value budget constraint of the
    household is, hence,
  • C1 C2/(1r)
  • Q1 Q2/(1r) (T1 T2/(1r))
  • and optimal consumption is given by the usual
    condition
  • MU1/MU2 (1r)
  • ? What matters is only the present value of taxes

9
  • The government has expenditures Gt in period t
    1,2, so its flow budget constraints are
  • G1 B1g T1
  • G2 T2 (1r) B1g
  • where B1g denotes government assets at the end of
    period 1.

10
  • Combining the flow government budget constraints
    we obtain the government present value budget
    constraint
  • G1 G2/(1r) T1 T2 /(1r)
  • ? The present value of taxes must be equal to the
    present value of expenditures.

11
Implications
  • Government policy matters only through the
    present value of expenditure.
  • Hence the timing of taxes and the budget deficit
    does not affect consumption, given government
    expenditures.

12
  • Since household savings are
  • S1 Q1 T1 C1
  • any reduction in taxes (T1) will be offset by an
    equal increase in savings.
  • ? Given government expenditure, an increase in
    the government deficit (caused by lower taxes)
    will be offset by an increase in private savings,
    leaving national savings and the CA untouched!

13
  • Another implication is that, to analyze the
    effects of changes of government expenditure, one
    can assume that the budget is balanced (i.e. Gt
    Tt)

14
The 1980s Twin Deficits, Again
  • One can conjecture that government policy
    affected the CA in the 1980s not because of the
    budget deficits, but because of increased
    government expenditures.
  • In our model, increases in government
    expenditures are just like falls in the
    households endowment.

15
  • However, this seems to be quantitatively
    insufficient government expenditures increased
    by about 1.5 of GNP between 1978 and 1985, so
    national savings and the CA would have fallen by
    at most that amount.
  • But the CA deteriorated by about 3.

16
(No Transcript)
17
(No Transcript)
18
Ricardian Equivalence May Fail
  • Possible causes
  • Borrowing Constraints
  • Intergenerational Effects
  • Distortionary Taxation
  • See SU, chapter 5 for a discussion.
Write a Comment
User Comments (0)
About PowerShow.com