Economics Working Paper 20114
Abstract: The fiscal response to the Coronavirus pandemic has increased federal government outlays as a share of GDP from about 20 percent to over 30 percent in 2020. Projections now suggest that outlays will decline temporarily to around 21 percent in the next few years, but then continue to rise toward 30 percent in the next several decades. In this paper we consider an illustrative fiscal consolation proposal that restrains the growth in federal spending. The policy is to hold federal expenditures as a share of GDP at about the 20 percent ratio that prevailed before the pandemic hit. We estimate the policy’s impact using a structural macroeconomic model with price and wage rigidities and adjustment costs. The spending restraint avoids a potentially large increase in future federal taxes and prevents the outstanding debt relative to GDP from rising from its current level. The simulations show that the consolidation plan boosts short-run annual GDP growth by as much as 10 percent and increases long-run annual GDP growth by about 7 percent.