[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

interest rate reduces investment. As we will see in Chapter 27, lower investment in
the present can reduce economic growth in the future, leading to lower incomes
and consumption.
Reducing the deficit or actually running a surplus has the opposite effect. It
allows the real interest rate to fall, stimulating private investment and thereby
promoting economic growth and better living standards in the future.
Wrap-Up
CONSEQUENCES OF GOVERNMENT DEFICITS
If the government runs deficits,
Some of the burden of current expenditures is shifted to future generations
directly.
Government deficits also reduce national saving, raise the real interest rate,
and lower the level of private investment, thereby making future generations
worse off.
If the government runs surpluses,
Some of the burden of future expenditures is shifted to the current
generation.
Also, repaying government debt increases national saving, lowers the real
interest rate, and increases private investment, thereby making future
generations better off.
Government Deficits and
Surpluses: Our Recent Experiences
In 1981, federal taxes were cut in the United States, but expenditures on defense
and social programs (medical, income security, and Social Security) increased.
Figure 25.5 shows the resulting increase in the federal deficit. In twelve years, from
1981 to 1992, the deficit more than quadrupled from $60 billion per year to $280 billion
per year. The economy grew over the period shown in the figure, as did the price
level, so a better measure of the size of the deficit is obtained by expressing the nominal
deficit as a percentage of nominal GDP. Even after making this adjustment, we
see that the increase in the deficit was dramatic, as panel B shows. The United States
experienced the first major peacetime deficits in its history.
During President Bill Clinton’s first term, a number of measures were adopted
to raise taxes and limit the growth in federal spending. These succeeded in reducing
the deficit. Beginning in 1998, the federal government actually started to run a
surplus, with tax revenues exceeding government expenditures. The surpluses were
short-lived, however. The federal budget swung back into deficit in 2002 as a result
of three factors: the economy entered a recession in 2001, and thus the taxes
558 ∂ CHAPTER 25 GOVERNMENT FINANCE AT FULL EMPLOYMENT