The Incredible Shrinking Deficit

IT's ironic: Just as the federal deficit shrinks sharply, the Republicans take control of both houses of Congress and set their sights on a balanced-budget constitutional amendment.

In fiscal 1994, which ended Sept. 30, the deficit recorded its largest one-year reduction in seven years, falling from $255 billion to $203 billion.

Of course, any figure followed by nine zeros is a lot of money. But in assessing the economic importance of a deficit, economists like to compare it with the nation's entire output of goods and services. By this measure, the deficit in the second quarter of this year was running at an annual rate of 2.2 percent of gross domestic product. That is less than half the rate of 4.5 percent in the same quarter of 1993.

That progress, says economist Michael Keran of Prudential Economics, is ``absolutely amazing.''

Indeed, as a percentage of GDP, the United States now has the smallest budget deficit of all the industrial nations, including Japan. ``Shocking as it seems, we are the good guys,'' jokes David Wyss, of DRI/McGraw-Hill, an economic consulting firm based in Lexington, Mass.

Economists don't expect the electoral shock to have much economic impact, at least in the short run.

The short run, according to Mr. Wyss, is two years. Mr. Keran holds that nothing the new Congress can do will affect the rate of growth of GDP, employment, or inflation over the next year - but it could have a significant effect over four to five years.

Wyss describes the Republican's ``Contract with America'' as ``relatively vague and self-contradictory.'' By his measure, it includes $220 billion in tax cuts, $70 billion in spending increases, plus an indeterminate amount of spending increases such as on defense.

``Another campaign run on a platform of cutting taxes, raising spending, and balancing the budget,'' he says with some sarcasm.

Two economic aspects of the Republican plan include:

r The balanced-budget amendment. If it gets through Congress next year, it could take four or five years to be ratified by at least 38 states. And probably the provision for a balanced budget would be phased in over another few years. So it could be 10 years before it is in place, Wyss reckons.

Keran sees low probability of the amendment becoming law.

But should approval become credible to the bond markets, the prospect of a zero federal deficit would reduce long-term interest rates by about 200 basis points (2 percentage points), Keran predicts. That would prompt a bond price rally that would make the 1992-93 rally look pale, says Keran, adding: ``It is a little hard to know just when it will become credible.''

A drop in long-term rates, however, won't have much impact on the economy as a whole, Keran says. Lower rates will boost the housing market, spending on automobiles and other durable goods (such as appliances and furniture), and business investment in structures. But at the same time, creditors, many of them older individuals, will see a reduction in their interest income and reduce spending on nondurable goods accordingly.

Max Sawicky, an economist with the left-leaning Economic Policy Institute in Washington, describes the amendment as ``the scariest thing on the agenda.'' It would be ``a formula for permanent recession'' by enforcing an overly contractionary fiscal policy, and thus depressing family income, personal saving, and business investment. It could also block more federal spending on infrastructure, education and training, environmental protection, and defense conversion, and jeopardize Social Security and Medicare, he argues.

Of course, some Republicans want the amendment as a way to shrink the role of government.

r Cuts in taxes on capital gains and the middle class. Both Wyss and Keran see some tax cuts as possible. But the impact on the economy may be minor.

``Experience shows that the economy grows at pretty much the same rate over any five-year period, regardless of tax law changes,'' Wyss notes. ``This economy is pretty resilient. It does pretty much the same thing no matter who runs the government.'' That he finds ``most encouraging.''

About these ads
Sponsored Content by LockerDome

We want to hear, did we miss an angle we should have covered? Should we come back to this topic? Or just give us a rating for this story. We want to hear from you.

Loading...

Loading...

Loading...

Save for later

Save
Cancel

Saved ( of items)

This item has been saved to read later from any device.
Access saved items through your user name at the top of the page.

View Saved Items

OK

Failed to save

You reached the limit of 20 saved items.
Please visit following link to manage you saved items.

View Saved Items

OK

Failed to save

You have already saved this item.

View Saved Items

OK