AN EXPERIMENT WITH MANDATORY BALANCED FEDERAL BUDGETS

THOMAS ORAL WISLEY, Purdue University

Abstract

In recent years there have been several attempts to legally require the Federal government to balance its budget through legislation and Constitutional amendments in Congress. This study analyzes the macroeconomic effects of requiring the Federal government to maintain a balanced budget. Proponents of mandatory balanced Federal budgets argue that requiring the Federal government to balance its budget will lead to lower rates of inflation and to lower interest rates. They also argue that this balanced budget policy will lead to more investment than there otherwise would have been. A small macroeconometric model of the United States economy is developed and estimated. The model takes the Federal government budget constraint explicitly into account. The model also makes prices, the expected rate of inflation, and the expected real rate of interest endogenous. Data series are developed for the latter two variables and are utilized in estimating real private expenditures equations. The model is used to simulate the effects of requiring the Federal government to maintain a balanced budget. We assume that budget balance is maintained by changing, in turn, each of the Federal expenditures variables and the Federal tax rate. We analyze each fiscal policy under two monetary policy assumptions. In general we found that requiring the Federal government to maintain a balanced budget will lead to lower interest rates and to lower rates of inflation. However, this is achieved at the cost of lower levels of real output and higher levels of unemployment than there would have been in the absence of mandatory balanced Federal budgets. We also found that under a mandatory balanced Federal budget policy real net investment in plant and equipment and in residential structures are reduced relative to what they otherwise would have been.

Degree

Ph.D.

Subject Area

Economics

COinS