Budget Deficits: Rhetoric and Reality

W v T hatever the real or imagined ills of the economy, the news media, most politicians and a fair proportion of the economics profession are quick to point to the culprit: "the budget deficit." No matter that few appear to know or care precisely what deficit they are talking about or how it is measured. No matter that few bother to explain in terms of a relevant model just how government deficits may be expected to impact the economy. No matter that few offer any empirical data to sustain their judgments. So budget deficits cause inflation. Budget deficits raise interest rates. Budget deficits bring on the trade deficits. Budget deficits crowd out investment. Budget deficits are an irresponsible mortgage on the future. And budget deficits caused the October 1987 stock market crash and now threaten further financial cataclysms! Is there truth in any of these assertions? Or does it all depend? Budget deficits do matter and their effects, contrary to Barro's "Ricardian equivalence theorem," can be substantial. As most economists have recognized for at least half a century, budget deficits can, however, be too small as well as too large. To know which, you have to measure them right. And you have to analyze their role in the world in which we live. Pure Walrasian and rational-expectation market-clearing models may prove more useful for academic advancement than for promotion of economic health. I need not repeat many of the objections to the equivalence theorem raised by Bernheim and Gramlich and addressed by Barro in this symposium. However, there is