Global Factors in Budget Deficits
Christopher J. Neely
Views do not necessarily reflect official positions of the Federal Reserve System. Global Factors in Budget Deficits D iscussions about fiscal deficits-government outlays less tax receipts as a percentage of gross domestic product (GDP)-often overlook the importance of global factors in common movements across countries. The left panel of the figure, for example, shows that deficits in Canada, France, Germany, the United Kingdom, and the United States declined from the mid-to the late-1980s,
... reased with the global recession of 1990, and then improved again from about 1992 through 2000. Recently, however, deficits have increased; in Germany and France, they are larger than the European Monetary Union limit of 3 percent of GDP. Why do national fiscal deficits tend to move together? One reason is that deficits react to common business cycle shocks. That is, global economic activity is subject to common shocks to technology, demographics, commodity prices, and political uncertainty. Further, international trade links countries' economies. Over a business cycle, government outlays fall and tax receipts rise with economic activity. Such changes are called automatic stabilizers; they make deficits vary with the business cycle. Governments often raise discretionary spending or cut taxes during periods of low output, further amplifying the connection of deficits to economic activity. Because countries tend to share 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 is called the cyclical deficit, while the structural deficit is the shortfall that would exist even if the level of economic output were at its potential. The right panel of the figure shows estimates of structural deficits. Structural deficits can result from changes in tax and spending preferences or external events.