The Reagan Deficit

Abstract

This paper analyzes the U.S. federal budget deficit during the Reagan administration and its short‐ and longer‐term consequences for the aggregate economy. While budget policies of the Reagan administration do not account for all of the increases in annual deficits or in outstanding federal debt during the Reagan era, an analysis indicates that the administration's program of tax reduction and defense spending build‐up were the major sources of deficit growth after the recovery from the recession of 1981‐82. For the near‐term future, the legacy of the Reagan deficits includes (1) the failure of domestically owned capital formation to expand at rates comparable to our major trading partners, (2) the necessity of diverting U.S. products and income to servicing foreign creditors, and (3) the need for rates of interest and profits to be high enough to induce foreigners to retain their holdings of U.S. assets lest divestiture cause a virtual collapse in the exchange rate. The final evaluation of the impact of the Reagan deficit hinges on whether the Reagan era of high consumption prosperity proves a good trade‐off with the consequences of attenuated macropolicy responses to recession, lower levels of U.S. owned capital stock, and remittances to foreign creditors.