Economic Report of the President 1994 - The American Presidency ...

Chart 2-15 Dynamic Effects of Deficit ReductionThe real effects of raising the saving rate through deficit reduction includehigher wages and investment and lower real interest rates.Percent12Percentage points10Wage(left scale)Marginal Product of Capital(right scale)0 5 10 15 20 25 30 35 40 45 50YearsSource: Council of Economic Advisers.rates will move by less than one for one. Other factors, such as expectationsabout the policy mix, therefore must explain the bulk ofthe rate reduction.A small increase in the investment rate buys a substantial increasein the capital stock, again over a long period. This increasein the capital stock should ultimately raise real wages and productivityby about 3 3 A percent.Initially, consumption falls because of the direct effect of the Federalbudget package. As output and productivity increase, however,so does consumption. It takes about 5 years for the change in fiscalpolicy to have a net positive effect on consumption. Thereafter, theeffect of the economic plan is to raise consumption permanently,eventually by more than 2V2 percent per year.These calculations are quite conservative. They do not assumeany externality from capital accumulation or any extra boost toproductivity from embodied technological progress. If these factorsare present, the gains from the increase in investment could besubstantially higher.86