What Do Budget Deficits Do?

Abstract

This paper discusses the effects of budget deficits on the economy in four steps. First, it reviews standard theory about how budget deficits influence saving, investment, the trade balance, interest rates, exchange rates, and long-term growth. Second, it offers a rough estimate of the magnitude of some of the effects. Third, it discusses how budget deficits affect economic welfare. Finally, it considers the possibility that continuing budget deficits in a country could lead to a 'hard landing' in which the demand for the country's assets suddenly collapses.