NY Fed paper discusses budget deficit impact on output

A new Federal Reserve Bank of New York staff report says cutting government spending on goods and services increases the budget deficit if the nominal interest rate is close to zero.

"The cut in spending reduces output and thus -holding rates for labor and sales taxes constant- reduces revenues by even more than what is saved by the spending cut," write the authors Matthew Denes, Gauti Eggertsson, and Sophia Gilbukh. "Similarly, increasing sales taxes can increase the budget deficit rather than reduce it," they add.

Both results suggest limitations of austerity measures in low interest rate economies to cut budget deficits. "Running budget deficits can by itself be either expansionary or contractionary for output, depending on how deficits interact with expectations about the long run in the model," says the paper.

Click here to read the paper.