Abstract

The main objective of this paper is to understand and to evaluate recently expressed popular anxiety about fiscal deficits. The paper begins with a discussion of problems involved in measuring the fiscal deficit. A general conclusion is that all interesting measures of the federal fiscal deficit have increased substantially over the past eight presidential terms and are likely to increase further in the near future. The paper goes on to analyze possible connections between fiscal deficits and inflation, economic growth, and fluctuations in the level and composition of economic activity. Fiscal deficit is the difference between current and capital expenditure and current receipts the debt trap. The fiscal policy is intended to play a key role in the prospective economic growth. It is not merely because of the fact that fiscal situation is a major component that determines the macroeconomic stability. Important conclusions are that of the monetary policy, inflation, and aggregate economic activity are all largely independent of the fiscal deficit, but that of the fiscal deficit can have major effects on the division of output between consumption and investment. Key elements in the analysis are the effects of taxation on consumption and investment demands and the relations between real and financial developments.

Key words: fiscal deficit, real exchange rate, financial integration, fiscal sustainability, EU, panel co integration.