The Economics of the Federal Budget Deficit

The Congressional Budget Office CBO estimates that the federal budget deficit for FY2009 was 1,414 billion, triple the 459 billion deficit recorded in FY2008. The CBO expects the deficit for FY2010 to be 1,349 billion. The estimate for 2010 is based on current law. The budget deficit in FY2009 was, in dollar terms, unprecedented. Compared to the overall economy, the 1.4 trillion budget deficit equaled 9.9 of gross domestic product GDP. In 1943, the budget deficit reached 30.3 of GDP. Since 1946 and before now, the largest the budget deficit had been, relative to the overall economy, was 6 of GDP in 1983. Over fairly short periods of time, say three or four years, fiscal policy can affect the rate of economic growth by adding to, or subtracting from, aggregate demand. For a time, the effect on the economy may even be larger than the initial change in the budget. These effects, however, tend eventually to diminish because of either higher interest rates or rising prices. There are varying estimates of the total effect on the economy of a change in fiscal policy, but most of them suggest that it reaches a peak somewhere between one and one-and-a-half times the size of the change in the budget. Most macroeconomists believe that effect is realized within one or two years of the initial change in policy.