Chapter 10

Question 1

What are the two options for the government?

Answer 1

Borrow and acquire interest on borrowed amount (not all tax revenue is spent)

Lend and get a return

• Ricardian equivalance - Government present discount value must be balanced therefore a deficit now means a surplus in the future. Budget deficit acquires interest must be balanced by surplus in the future, so the presetn discounted value is balanced
  *

Question 2

What do recent forecasts show?

Answer 2

Fiscal policies are unsisutainable

• Shocks (E.g. Financial crisis, COVID, Russian invasion of Ukraine)
• Demographic change
  
  • Healthcare (Tendency for an ageing population, who are a strain on healthcare)
  • Pension system (Pay pension to more people for longer)

Question 3

Flow version of governmetn budget constraint

Source of funds must be equal to uses of funds

Answer 3

• Debt has different maturity, but in the equation, we aggregate it
• Transfer payments: Unemployment benefits, subsidieies given to firms and households
• Issue new debt if taxes do not cover government purchases
• Monetary aggreaget is minimal in developed countries and is essentially printing more money.

Question 4

Primary deficit

Total deficit

Answer 4

Growth in deficit because it acquires interest

Primary deficit does not include spending on interest payments

Question 5

What is the budget balance?

Answer 5

Difference between tax reveneues and spending

Question 6

What is a budget surplus?

Answer 6

Tax revenue > Spending

Question 7

Budget deficit

Answer 7

Tax reveneue < Spending

• The government must borrow by selling bonds

Question 8

Balanced budget

Answer 8

Tax revenue = spending

• No need to issue additional debt

Question 9

WW2

Answer 9

US: War spending and recenues were an approximately stable fraction of GDP. Deficits emerged in 1970s

Europe: Welfare building increased deficits

Question 10

Debt to GDP ratio

Answer 10

Primary balance: pb_t

• Interest rate = Growth rate: debt remains the same forever
• Interest rate> growth rate: debt will grow because accumuilation is higher than growth, as interest payments increase the accumulation of debt
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Question 11

Budget constraint for period 1

Answer 11

B₂=(1+i)B₁+G₁-T₁

Question 12

Budget constraint for period 2

Answer 12

B₃=(1+i)B₂+G₂-T₂=0

Only 2 peiods therefore there must be a balanced budget

Question 13

Intertemporal budget constraint

Answer 13

The government’s budget must balance—not period by period, but rather in a present discounted value sense.

Question 14

Debt to GDP ratio

Answer 14

Pay interest on outstanding debt

Changing because of primary balance pb_t

Question 15

What happens when GDP is growing faster than interest rate?

Answer 15

Debt to GDP ratio will tend to decrease

Question 16

What happens when GDP is greater than the growth rate?

Answer 16

Economy is accumulating debt

Question 17

What is the impact of a negative primary deficit?

Answer 17

Falling debt to GDP ratio, as government is paying back the debt

Question 18

Calculating changes

Answer 18

Question 19

How much can a government borrow?

Answer 19

Economic growth being low means debt to GDP ratio will rise if interest rates are high

Intergenerational equity is the fairness of future generations (Do we want the future society to pay back more taxes for the debts of the current society?)

Crowding out investment: Higher deficit reserve resources from the private sector and reduces investment

Question 20

What limits the amount the government can borrow?

Answer 20

• Amount it can credibly be expected to pay back
• How large the economy is
• Stable economic growth and debt-gdp ratio, as well as good credibility is the key assumption that the stock of debt will stabilise and go down

Question 21

What happens to the stock of debt when the GDP is growing even faster?

Answer 21

Debt-GDP ratio will fall if this happens

Question 22

What happens when debt-GDP ratio becomes too high?

Answer 22

Lenders worry about the ability of the governmetn to repay = investors demand higher interest rate, as they want compensation for the risker loan

Question 23

What is the impact of printing money as a reuslt of the increasing interest?

Answer 23

Inflation

Question 24

What happens when a governmetn defaults?

Answer 24

Government declares it will not repay certain debts

Or it will them at less face value

Government therefore has limited access to investors and in many cases has to seek international organisations

Question 25

Who are the ones who pay back governmetn debt?

Answer 25

Beneficiaries of borrowing may not be the same

Question 26

Generational accounting

Answer 26

Developed by US economists

Calculates the extent to which current policies pass on tax burdens to future generations

Higher and rising debt-GDP ratio = higher tax for future generations

Question 27

What is the national income identity?

Answer 27

Investment equals total savings

Assume no transfer payments

Question 28

How can investment be financed?

Answer 28

• Savings from the private sector
• Government saving
• Savings by foreigners

Question 29

What is crowding out?

Answer 29

Budget deficit absorbs some of the savings and reduces investment

Question 30

What is the reason for unsuistainable current policies?

Answer 30

• Increasonn generosity of entitlement payments
  
  • Pay as you go vs fully funded pension systems
• Rise in shre of the population recieving pension benefits for longer
• Rise in similar healthcare expenditures (Expsnive technology rise expenditures. Waste and fraud are probably not explaining expenses. Spending growing in rich countries)
  
  • Growth of cost per person higher than GDP growth

Question 31

What are the solutions to get tax revenue back on track?

Answer 31

Increase taxes

Reduce spending