The danger of adopting deficit rules is that deficits are not permitted during recessions, thereby adding to the recession, says Dimitri B, Papadimitriou, Economist, Levy Economics Institute, US.
Over the last two decades, it has become the conventional wisdom that specific rules should govern the size of budget deficits, without regard for the impact of such deficits on the macroeconomy. In the US, this is reflected in the push for `fiscal responsibility' and the accusations levied on President Bush for expenditure frivolity. What I hope to show in this article is the "relationship of government deficits to the growth of an economy" and my comments will center on the US economy.
It is generally assumed that the actual budget position would fluctuate with the business cycle, though clearly the danger of adopting deficit rules is that deficits are not permitted during recessions, thereby adding to the recession. As my late colleague Hyman Minsky (1992) had pointed out, in many of his writings, a balanced budget and the non-monetization of the deficit would mean that no high-powered money (cash and bank reserves with the Fed) would be created. This means that the money supply would grow below the growth of real output and the reserve ratio of the banking system would decline, both leading the economy deeper in the downturn.
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