The consequences of massive budget deficits

September 3, 2009

The Cleveland Fed gives the bad news:

First, without a correction on the spending side, more tax revenue will need to be raised, with the consequence of subjecting the economy to greater tax-associated inefficiencies.

The risk of default may also increase, leading to higher risk premiums, higher interest payments, and a greater cost to be sustained in the future to address the fiscal imbalance.

In addition, a sustained demand for funds by the government sector will likely put upward pressure on future real interest rates, with adverse consequences for private investment and growth.

The increase in domestic interest rates will likely attract further financial flows from countries with higher saving rates, which may lead to a dollar appreciation and a worsening of our current account deficit.

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