7
Richard W. Kopcke, Geoffrey M. B. Tootell, and Robert K. Triest
spending will be much the same as if there had been no change in fiscal
policy. If, instead, consumers spend much of their additional disposable
income while the economy is already at full employment, personal sav
-
ing will not rise sufficiently to offset the drop in public saving, inter
-
est rates will rise, and investment spending will decline, unless business
saving (resulting from the additional consumption spending) or capital
inflows from abroad increase sufficiently to make up the difference. If
the economy is not at full employment, national income might expand as
a result of the cut, providing additional income-tax receipts and saving,
and thereby preventing a drop in national saving. In either case, a tax
cut that increases the return on capital can increase business saving and
attract, for a time, an inflow of foreign saving sufficient to maintain total
saving and investment. If, however, fiscal policy depresses investment,
then both the capital stock and economic output will be lower in the
future than they otherwise would have been. The lower capital stock will
tend to be accompanied by real interest rates that are higher than they
otherwise would have been.
If capital inflows from abroad increase sufficiently to offset any drop in
national saving resulting from a change in fiscal policy, then investment
need not fall. In this case, the current account deficit, which is equal to
the quantity of capital inflows from abroad, will increase at least enough
to offset the increase in the budget deficit less the induced increase in
private saving. The future levels of the capital stock and real output will
not fall, but future domestic consumption will be reduced because an
increased share of the return to capital will accrue to foreign nationals—
unless the fiscal policy fosters a greater utilization of the stock of capital,
greater capital formation, or greater net returns on capital to compensate
for the outflow. The concurrent large budget and current account deficits
that occurred in the early 1980s and again in the last few years have led
many to believe that increases in the current account deficit would gener
-
ally accompany large increases in the budget deficit, and gave rise to the
term “twin deficits.”
Tension Between Short-Term Stabilization and Long-Term Goals
In the discussion so far, it is apparent that there is a potential conflict
between the use of fiscal policy to stimulate aggregate demand when the