16.2 Two Analytical Issues

Question 1

What are two issues that we must examine before we discuss some macroeconomic effects of budget deficits and surpluses?

Answer 1

Before we can discuss some of the macroeconomic effects of budget deficits and surpluses, we must examine two analytical issues: the stance of fiscal policy and changes in the debt-to-GDP ratio.

Question 2

What does the level of nettax revenue typically depend on?

Answer 2

As we first discussed in Chapter 7, the level of net tax revenues typically depends on the level of real GDP, even with unchanged policy.

Question 3

What is the typical effect on government transfers as GDP rises?

Answer 3

In addition, as GDP rises there are typically fewer transfers (such as welfare or employment insurance) made to the private sector. Thus, net tax revenues, T, increase when GDP increases.

Question 4

is the relationgship between government purchases and debt-service payments dependent or independent of the level of GDP?

Answer 4

In contrast, the level of government purchases and debt-service payments can be viewed as more or less independent of the level of GDP, at least over short periods of time.

Thus, with no changes in the government’s fiscal policies, the budget deficit will tend to increase in recessions and fall in booms.

Question 5

Is there a positive or negative relationship between real GDP and the government’s budget defficit?

Answer 5

That is, there is a negative relationship between real GDP and the government’s budget deficit.

For a given set of expenditure and taxation policies, the budget deficit rises as real GDP falls, and falls as real GDP rises.

Question 6

What is the budget deficit function?

Answer 6

Budget deficit function
A relationship that plots, for a given fiscal policy, the government’s budget deficit as a function of the level of real GDP.

Question 7

What determins the position of the budget defict function and what leads to movements along one?

Answer 7

Fiscal policy determines the position of the budget deficit function. Changes in real GDP lead to movements along a given budget deficit function

Question 8

What is the actual budget deficit the sum of?

Answer 8

At any given time, the actual budget deficit is the sum of two components—the structural and the cyclical deficits.

Question 9

What does the structural deficit reflect?

Answer 9

The structural deficit reflects the amount of the deficit that is due to the underlying design of fiscal policy, independent of the current level of GDP.

Question 10

What does the cyclical defict reflect?

Answer 10

The cyclical deficit reflects the amount of the deficit that is due to actual GDP being either above or below the level of potential GDP. By definition, the cyclical deficit is zero when real GDP equals Potental output; at the same time, the structural deficit may be positive, negative, or zero.

Question 11

When the real DGP equals potential, what level of cyclical and structural defict exists?

Answer 11

When real GDP equals Potential, there is no cyclical component to the budget deficit. Whatever deficit then exists is the structural deficit.

Question 12

What is the Structural Budget Deficit?

Answer 12

Structural budget deficit

An estimate of what the government budget deficit would be if real GDP were equal to ; sometimes called a cyclically adjusted deficit.

Question 13

Why is the structural budget deficit sometimes called the cyclically adjusted deficit?

Answer 13

The structural budget deficit is sometimes called the cyclically adjusted deficit because in order to measure it we estimate what the budget deficit would be with current policies in place but under the assumption that GDP is at potential

Question 14

The Structural Budget Deficit and Changes in Fiscal Policy (graph)

Answer 14

The change in the stance of fiscal policy is shown by the resulting change in the structural budget deficit.

Question 15

What is the effect of inflationary and recessionary gaps on the actual budget deficit?

Answer 15

Question 16

Why can we not mearly examin the change in the budget deficit in order to identify how a change in the stance of a fiscal policy is best identified?

Answer 16

We cannot merely examine the change in the budget deficit, because the deficit will change whenever Y changes even in the absence of a change in fiscal policy.

Any change in the structural deficit, however, does reveal a change in underlying fiscal policy.

Question 17

What directions does expansionary and contractionary changes in fiscal policy shift the budget deficit function?

Answer 17

an expansionary change in fiscal policy shifts the budget deficit function upward and increases the structural deficit. A contractionary change in fiscal policy shifts the budget deficit function downward and reduces the structural deficit.

Question 18

how is a change in the stance of fiscal policy identified? What does such a shift indicate?

Answer 18

A change in the stance of fiscal policy is identified by a shift in the budget deficit function.

Such a shift indicates a change in the structural budget deficit.

Question 19

What is the difference in how we measure the actual budget defiit and how we measure the structural deficit?

Answer 19

Unlike the actual budget deficit, which can be precisely measured, the structural deficit can only be estimated. The reason is that its value depends on the value of potential GDP , which itself is not directly observable and hence must be estimated.

Question 20

Actual and Structural Budget Deficits, Combined Government, 1980–2019

Answer 20

Question 21

What does the difference between the actual and structural budget deficit reveal?

Answer 21

The difference between the actual budget deficit and the structural budget deficit reveals the level of output compared to potential.

Question 22

What do the changes in the strucural deficit show us?

Answer 22

The changes in the structural deficit show changes in the stance of fiscal policy.

Question 23

When is the actual budget deficit above and below the structural deficit?

Answer 23

The actual budget deficit is above the structural budget deficit when output is below potential.

The actual deficit is less than the structural deficit when output is above potential.

Question 24

What does an increase and a decrease in the structural eficit reaveal?

Answer 24

An increase in the structural deficit reveals a fiscal expansion.

A decrease reveals a fiscal contraction.

Question 25

How are changes in the stance of a fiscal policy shown?

Answer 25

Changes in the stance of fiscal policy are shown by the changes in the structural deficit.

Question 26

Why do economits often discuss the governments debt-to-GDP ratio rather than the absolute amount of government debt?

Answer 26

As we have already observed, in order to gauge the importance of government deficits and debt, they should be considered relative to the size of the economy.

This is why economists often discuss the government’s debt-to-GDP ratio rather than the absolute amount of government debt.

Question 27

A simple expression that relates the government’s primary budget deficit to the change in the debt-to-GDP ratio.

Answer 27

Question 28

This simple equation (budget deficit to the change in the debt-to-GDP ratio) shows two separate forces, each of which tends to increase the debt-to-GDP ratio. What are they?

Answer 28

First, if the real interest rate exceeds the growth rate of real GDP (if r exceeds g), the debt-to-GDP ratio will rise for the simple reason that the debt accumulates at a faster rate than GDP grows.

Second, if the government has a primary budget deficit (if x is positive), the debt-to-GDP ratio will rise because the government is incurring new debt to finance its program spending.

Question 29

In what situation must the government run primary budget surpluses?

Answer 29

If the real interest rate on government debt is approximately equal to the growth rate of real GDP, reductions in the debt-to-GDP ratio require the government to run primary budget surpluses.