Budget Analysis Flashcards
What are discretionary spending and mandatory spending? Compare those two and provide examples.
Discretionary spending is optional spending mostly used for defense, optional programs. The government has control over it. Mandatory spending (or entitlement spending) is required by law, the government has no control over it (Sodra money, medicare, pensions). The main difference between the spendings is the control of government.
Do we really have control over our budget?
No, since the percentage of most of spending is mandatory spending, we do not have control over it. We are obliged to pay people the money they own from the government.
What kind of countries tend to have higher budget deficits? Why this helps them?
Richer countries tend to have higher budget deficits because they engage in more deficit spending, which helps them in the long run with upcoming crises.
Which countries can borrow more?
Richer, since their credit history is better.
What kind of countries tend to have higher social mandatory spending?
Richer, as you get richer and older mandatory spending tends to grow.
Why is it difficult to compare the budgets of different countries? What budgeting US uses? Why?
One country may use capital budgeting, the other may use current budgeting. US uses current accounting. It does not use capital accounting since it can be abused.
What is capital budgeting? Explain by providing example.
Can be used when we want to reduce budget deficit or make it look smaller. For example, if the government is considering building the bridge, they can spread the costspan and do not account for during its lifeall the costs in year 1 (because the bridge gives benefits throughout the years).
What are the problems in capital budgeting?
We cannot know the exact depreciation and amortization schedule. We cannot also determine what is investment spending at what is not.
What problems are when using current budget? Explain by providing an example.
In 90s there were a lot of cell phone sales, so those sales made the budget surplus but actually, you cannot account those as income, since you only change asset’s liquidity (from cash to asset).
What example can be provided with Greece and budget accounting?
Greece wanted to join EU, therefore had to reduce its budget deficit to meet Maastricht criteria (3%). So, it has started selling its inneficient state railway shares to the government which made the budget deficit smaller.
How many countries/states/cities try to limit their spending by law? Why do this?
Balanced Budget Requirement (BBR). The budget is really important for the macroeconomic health of the country.
What budget deficit is allowed in EU?
3%
What debt to GDP ratio is allowed in EU?
60%
When times are bad is it better to run large budget deficit?
Yes
What is Keynesian theory?
IS-LM macro model. More government spending or tax cuts stimulate the economy in the short-run (should not be done for a long time).
Why should we smooth booms and drops in the economic cycle?
When you have high levels of the economic booms, you might overheat the economy, high levels of inflation. When you have high levels of drops, you have high levels of unemployment.
Why overcompensation appears?
Let’s say that we are in the recession, and it takes time for the government to meet, to approve the budget and when that is done, we are already at the boom, which makes overcompensation - due to time lags.
What is automatic stabilization? Provide examples. Where this policy shows great results?
Policies that automatically reduce tax collections or increase government spending if there is a recession (progressive income tax, corporate tax, unemployment benefits). In EU this turned out as a great policy.
What is discretionary stabilization?
Direct policy actions taken by the government in response to business cycle (fiscal stimulu cheks in US, unemployment insurance extensions).
What is short-run stabilization?
The idea to smoothen business cycle peaks and downs.
What kind of policy is better for “V” shaped recession? Why?
Automatic stabilizers because recession is short.
What kind of policy is better for “U” shaped recession? Why?
Discretionary stabilization by issuing stimulus cheks, getting something that kicks the economy growing again.
What is a liquidity trap?
Situation when interest rates are nearly zero, it is better for people to hold money in cash.
What policy should be used in case of liquidity trap?
Fiscal policy - we need to increase GDP and spread out the IS curve.
If consumer spending decreased, what policy can be implemented? Why automatic stabilizers would not work in this case?
You should use discretionary stabilization like stimulus checks. Automatic stabilizers won’t work since people are losing their jobs, therefore no taxes are being paid.
What group of people was least spending during covid? What the most?
Poor - the most, rich - the least.
What group of people were affected the most by stimulus checks?
Poor people
If we are trying to design an optimal stimulus package what should we do?
Do not give money to the rich because they are not responsive.
Why too many stimulus payments are not a good idea?
You might put pressure on inflation.
If poor people are spending more now, why there are still huge levels of unemployment?
As businesses lost their high-income customers (irresponsive to stimulus checks), they lost a big portion of their revenue, therefore had to laid its workers.
What policy can be implemented to reduce unemployment?
Stimulus payments to households and Paycheck Protection Program loans to small businesses that lost most of the revenue.
To what extent Lithuania and US are not similar when it comes to the issues faced by covid?
Lithuania aimed to rescue people who were affected (businesses, workers), the US used stimulus checks.
How fiscal policy works in a closed economy? And how in small open economy? What conclusion could be made about fiscal stimulus?
You have high propensity to consume - fiscal multiplier. The government is spending more money, you get the money and then you spend it in a circular economy. In open economy, if you buy a computer that was not made there, you are sending the money out of the economy - no fiscal multiplication is happening, when you buy something in the small economy. Therefore, fiscal stimulus could only be made in closed economy.
If the government is trying to borrow money to do stimulus from where does it come from? What conclusion can be made from that?
Savings. Debt is affecting net savings, so it affects the level of investment in the country.
Savings formula
savings = gov debt + investment
Explain what is crowd out.
If savings is a fixed pool, more government debt means less loanable funds for investors - government crowds out the investments spending.
What are two mitigating factors when it comes to crowd out?
1) In an open economy the pool is not fixed (as Lithuania you can get free capital movement from EU, US, etc.) But where the economy is closed, the pool is relatively more fixed - US.
2) If people are fully rational, they will save more money because they know that the higher level of debt means higher taxes - Ricardian equivalence.
What is Ricardian equivalence?
People being rational are saving more money now because they know that the higher levels of government debt means higher taxes in the future, so they will save more money today.
What economic theory could be provided when government borrows to much and it decreases the supply of loanable funds?
Government spending (especially stimulus spending) will increase the interest rates and have a long-term negative impact on investment spending.
What is the formula for national savings?
S = Y - C - G
How can we increase government spending without crowding out?
Increase it through taxation, since taxation terms cancel out.
How budget deficits affect our trade balance?
We are going to more import, as interest rates are increased, exchange rate increases, you start less exporting stuff, lower investment rates.
Who benefits when the interest rates are raised?
The rich, because they are capital owners.
Does Lithuania has to worry about crowd out?
No, since small open economies world interest rate is not affected.
Why there might be that during recessions interest rates go down? What happens to effects on crowd out? (Evidence based policy)
CBs are doing monetary policy and lowering interest rates, which cancels out the effect of having higher interest rates, which cancels out the crowd out.
Are official debt levels real?
A lot of debt is the debt that government owns to it self.
What is the Austerity Debate?
Should we be increasing government debt and do more stimulus spending or should we be trying to be more responsible and reduce government debt?
What is Hard Landing? Is it for the austerity or against?
The downside of having large debt that might lead to economic crisis. It is for austerity (tightening your belts, avoid debt)
How Hard Landing can be caused? (2)
1) High Debt-to-GDP ratio
2) New governments are untrustworthy by international investors
What are the effects of Hard Landing? What countries can be examples?
1) Asset prices prices fall (people are pulling their money out of the economy)
2) Currency depreciates
3) Capital Flight
Examples - Greece or Argentina
What was the main idea of (in)famous paper “Growth in a Time of Debt” originally?
The countries with high levels of Debt-to-GDP rates have lower economic growth.
Why might high levels of public debt stop economic growth?
Crowding out - if you have high debt now, you are going to pay back in the future and spend less in the future.
What is the Austerity proposition to sustainably grow?
Reduce debt.
What is IMF’s perspective on debt?
Debt reduces investment potential (crowd out), inherited public debt burdens the economy.
Why debt is destructive?
Because of taxation.
What IMF suggests in debt’s reduction?
To retain fiscal space (you have the ability to borrow more, but you are not maxed out on your credit card. If you have fiscal space there is no need to pay down your debt now. You should focus on growing the economy, which later will turn out to getting out of your debt.
What country has a lot of fiscal space? What this means?
Norway, they can borrow lots of money if they need to.
If government reduce its spending what is going to happen to GDP? Why this is strange in terms of reality?
It should decline. In reality, GDP can grow because investors see that spending is reduced, therefore interest rates are low and they are going to spend more money.
Why Paul Krugman called Baltic countries stupid for doing austerity?
They did austerity (spending cuts) and experienced growth in terms of GDP. He was wrong.
If Lithuania government had listen to the advice of not doing the austerity during crisis, what would have happened to the economy? What about loans?
They would have not met Maastricht’s criteria. They could have gone to the IMF and taken loans for small interest rates, but that would have sent a signal to the investors that the country is messed up and capital flight would have happened.
What Estonia did better than Latvia and Lithuania in terms of budget balance?
They were running surpluses on the booms and deficits on the recessions which made everything easier.
What is internal devaluation?
When you let your wages and price levels decline.
Why in reality labor decrease is not a bad thing?
You are reducing labor costs, which is making businesses more healthy, increasing exports.
What is cyclically-adjusted budget balance (CAB)?
Budget that takes into account whether we are in a recession and allow to do fiscal stimulus or in a boom.
What is output gap (OG)?
The difference of current level GDP and potential.
What country uses cyclical budget?
Chile
Why Lithuania would not get penalized by EU if we would run real budget deficits?
It wouldn’t show up in the structural budget deficit.
