Do The Federal Deficits Matter?

Abstract

The sharp and sustained increases in the budget and current-account deficits have once again raised a great deal of concern among many economists on the reemergence of the twin deficits of the1980s and their impacts upon macroeconomic variables. In view of majority of economists, these developments will be creating economic problems such as high real rates of interest, low savings, stagnant economic growth, large and persistent current account deficits, and probably a higher inflation. All economists, however, do not share this view. Those associated with the writings of Robert Barro, argue the Ricardian Equivalence Theorem that budget deficits do not matter and they have no real effects on the economy. The empirical evidence on this issue has been rather inconclusive. In contrast to the previous studies that have used single equation, I use a balance of payment model to investigate simultaneously the impacts of budget deficits on a number of macroeconomic variables using a system of simultaneous equations.