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I would define a structural deficit as one which will occur indefinitely without a change in the level of government programs provided or in taxes. It's a small distinction, but I don't think you can start predicting the behaviour of future governments that haven't even been elected yet. Rather than start predicting how future governments will spend, which is purely speculative, it's more concrete to look at what it will cost to maintain the same level of government services.

David: that won't work. What's a "change"? Do you mean a change in the level of G and T, or g and t? Or what?

Nice post, Nick. One practical problem with implementing David's suggestion - which makes a lot of intuitive sense - is how do you apply it to health care? The Canada Health Act requires the provinces to cover all medically necessary hospital and physician services, but as technology changes, so does what is medically necessary.

Thanks Frances, but I'm not sure if I have a good answer to the question I posed.

Another way of posing it is this: when we project future revenues and expenditures, what exactly is it we are holding constant? To answer "no new Acts of Parliament", or something like that, seems to make the definition so arbitrary. Your example of the Canada Health Act is a case in point. If we had a different Canada Health Act, but where governments updated what was covered annually to include new technology, so we got to exactly the same level of expenditure in practice, would we want to say the structural deficit was any different? I wouldn't.

I remember Jean Chretien saying something years ago, before he was PM. Something like: "People keep saying the CPP (or something) is in a deficit, and we are headed for disaster. That's like a passenger in my car yelling 'Look out Jean! You are driving straight towards that mountain!' and I reply 'Yes, but the mountain is still one km away. When we get closer, I will turn the steering of course, so what are you yelling about?'"

Now, in Jean Chretien's example, you could perhaps have made a good case that he should have turned the CPP steering wheel sooner. But in the current case, it's not at all obvious we should take action immediately. And what does "taking action" mean, anyway?

I highly recommend this related piece on the "debt snowball" dynamic:


The author lays out the case for a "structural deficit": it is the deficit needed to stimulate the economy and create sufficient inflation such that the nominal interest on the debt does not, for a sustained period, exceed the growth in NGDP. The problem, of course, is that the same level of sustained deficit also increases the level of the debt, and this dilemma is the source of the "snowball" effect.

There is an underlying assumption here: that an economy needs to run a large deficit to escape deflation. One potential reason is that, in a period of deflation and falling velocity (i.e. shrinking bank credit), the only way to put money in circulation (and not just increase Excess Reserves), and therefore make credible Central Bank inflation targets, is to run large deficits. Governments, such as Greece and Ireland, try to maintain NGDP by running large deficits. However, as expectations for debt growth rise, they face a debt downgrade have to resort to fiscal austerity. However, fiscal austerity leads to lower NGDP growth, which just makes the problem worse.

The counter-argument is that the Central Bank can credibly raise inflation expectations without the fiscal authorities running large deficits. That may be true in theory, but what about in practice? Say the Fed adopts a 4% inflation target for fiscal 2011, and the Treasury proposes a balanced budget, causing the fiscal deficit to go from over 10% to zero. Could NGDP rise in this situation? I find that hard to believe. Therefore, if fiscal deficits cannot be removed without crashing NGDP, then they are structural. Nick would probably reply that they can easily be removed once the cycle turns and "organic" growth resumes; but that assumes that the NGDP cycle can turn while actors expect a massive reduction in stimulus. Another option is to "straight line" the deficit downward. Again, market expectations of austerity can affect NGDP growth, and that is precisely the problem faced by Ireland and Greece today.

So I would say the definition of a structural deficit is one that a government cannot reduce without incurring successive debt downgrades caused by expectations of falling NGDP. That is, one which the Central Bank must, therefore, eventually step in to finance. A corollary is that structural deficits exist when the habitual use of fiscal stimulus has created an economy dependent on it for NGDP growth expectations.

BTW, examples of such economies have abounded in Latin America, and now we have Greece, Ireland, Spain, potentially the UK, and eventually, also, the U.S..

I would say that a true structural deficit is once the government deficit is too high to still offer basic services at high tax rates. For example, if the debt levels became high enough in which an economy the government could no longer borrow(keeping in mind I'm thinking of an economy with a sound currency, gold standard for example, not ideal but an example). I think a structural deficit should be a term for which government spending is beyond the possibility of citizens to enjoy services such as health care(if it was government-run) in which all individuals would be taxed 98% for example, and the lenders would stop lending the government money, and thus be forced to engage in austerity in order to pay off the deficit. But even to that, prices would adjust to the income available and individuals would live despite the large tax rates... maybe I'm just being ridiculous in this thought. Deflation would occur with the lack of available money, or would it remain at similar levels due to tax rates? Actually, if deflation occurred, then the deficit would remain for a longer period, but prices would adjust to a good living standard? Someone answer me on that one.

The typical definition would normally be when the deficit will grow year after year if nothing is done.

By change, I mean a change in t (the tax rate) or "real G" (real government spending). In other words, a structural deficit is when growth isn't going to get us back to a balanced budget within the foreseeable future, so we have to either raise taxes or cut programs. I think thinking of cuts in terms of how citizens usually see them -- their effect on the final product -- is most useful and thus real government spending is more appropriate than actual government spending.

Actually one thing I would like to see is some of the recent advice given to developing countries that has been effective, being also applied to large western countries.

I think a lot of structural deficit comes from bad policies that raise the transaction costs in the labor market.

Speaking of transaction costs, if a country got rid of their income taxes and payroll taxes and replaced them with a VAT would they see both consumption and unemployment decrease?

Oh wow my bad, Nick. For some reason I got this blog confused. I was thinking of "structural unemployment." I need to pay more attention to where I am posting.

You had me a bit confused there Doc!

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