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Economic SYNOPSES
short essays and reports on the economic issues of the day
2003 ■ Number 26

Global Factors in Budget Deficits
Christopher J. Neely
iscussions about fiscal deficits—government outlays less
rity expenditures. Indeed, the U.S. deficit in 2002 (3.4 percent of
tax receipts as a percentage of gross domestic product
GDP) was mostly structural (2.9 percent), not cyclical.
(GDP)—often overlook the importance of global factors
The international correlation in structural deficits illustrates
in common movements across countries. The left panel of the
that the business cycle is not the only global influence on fiscal
figure, for example, shows that deficits in Canada, France,
deficits. For example, the “peace dividend,” the cuts in defense
Germany, the United Kingdom, and the United States declined
spending after the fall of the Soviet Union, accounted for some
from the mid- to the late-1980s, increased with the global recesof the international fall in structural deficits in the 1990s. Similarly,
sion of 1990, and then improved again from about 1992 through
the extraordinary international bull market in equities in the late
2000. Recently, however, deficits have increased; in Germany and
1990s—which was only weakly related to real economic activity—
France, they are larger than the European Monetary Union limit
probably reduced deficits by increasing tax revenues on capital
of 3 percent of GDP.
gains. The decline in equity prices since 2000 has been associated
Why do national fiscal deficits tend to move together? One
with a falloff in tax revenues on capital gains. Finally, the Maastricht
reason is that deficits react to common business cycle shocks.
Treaty, which established the European Monetary Union on
That is, global economic activity is subject to common shocks to
January 1, 1999, limits deficits to 3 percent of GDP. This treaty
technology, demographics, commodity prices, and political uncerobligation forced cuts in French and German deficits in the 1990s.
tainty. Further, international trade links countries’ economies.
In evaluating deficits, one should carefully consider the source.
Over a business cycle, government outlays fall and tax receipts
Cyclical deficits, which often have a strong global component,
rise with economic activity. Such changes are called automatic
do not threaten long-term fiscal solvency because they will be
stabilizers; they make deficits vary with the business cycle. Governreversed over time. However, large structural deficits—those
ments often raise discretionary spending or cut taxes during
greater than the country’s average output growth rate—cannot
periods of low output, further amplifying the connection of
be maintained forever and might require adjustments to tax and
deficits to economic activity. Because countries tend to share
spending policies. ■
business cycles, which are correlated with deficits, deficits tend
to be correlated internationally.
The portion of a deficit that is
due to the level of economic activity
Fiscal deficits
Structural deficits
% of GDP
Canada
% of GDP
Canada
is called the cyclical deficit, while the
10
10
France
France
structural deficit is the shortfall that
Germany
Germany
8
8
UK
would exist even if the level of ecoUK
US
6
US
nomic output were at its potential.
6
The right panel of the figure shows
4
4
estimates of structural deficits.
2
Structural deficits can result
2
0
from changes in tax and spending
preferences or external events. For
0
–2
example, the U.S. deficit rose in 1992
–4
–2
when savings and loan depositors
1980
1985
1990
1995
2000
1980
1985
1990
1995
2000
were bailed out. And the terrorist
SOURCE: OECD Economic Outlook.
attacks of September 11, 2001, and
NOTE: The panels show fiscal deficits and structural deficits as a percentage of GDP. Deficits are measured as
wars in Afghanistan and Iraq surely
a percentage of GDP because larger, richer economies can more easily afford to run higher deficits than can
inflated the U.S. deficit through
poorer countries. Figures for 2003 and 2004 are projections.
higher defense and homeland secu-

D

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