What were the principal causes of the U.S. government budget deficits of the 1980s? How did these budget deficits lead to the twin deficits? According to the Ricardian equivalence proposition, should twin deficits arise as a result of tax cuts?
What will be an ideal response?
The principal causes of the U.S. federal government budget deficits of the 1980s were a reduction in government revenue (in part because of the Economic Recovery Tax Act of 1981 ) and increased military spending. The twin deficits arose because the increased government budget deficit reduced national saving, leading to a current account deficit. According to the Ricardian equivalence proposition, a government budget deficit created by a tax cut will have no real economic effects because it will not affect saving. According to this theory the government budget deficit and the trade deficit are independent events.
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Suppose that we reduce the federal budget deficit (in billions of dollars) in year 1 from 300 to 200 and in year 2 from 200 to 100. During these two years the national debt will
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A. at a profit. B. at a zero economic profit. C. in the long run. D. in the short run.
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