Chapter 16

Question 1

What is the government’s budget constraint?

Answer 1

Government expenditures must be financed by income or by borrowing.

Question 2

What is the government budget constraint equation?

Answer 2

Government expenditure = Tax Revenue + Borrowing

Question 3

What are the 2 categories of government expenditure?

Answer 3

1. Purchases of goods and services, G
2. Interest payments on the outstanding stock of debt, which is referred to as debt-service payments, and is denoted as i ×D

Question 4

What is the borrowing equation?

Answer 4

(G + i × D) – T = Borrowing

Question 5

What does G represent?

Answer 5

Government spending on Goods and Services

Question 6

What does i x D represent?

Answer 6

Interest payments on outstanding debt

Question 7

The government’s annual budget deficit is the what?

Answer 7

Excess of government expenditure over tax revenues in a given year.

Question 8

The annual deficit is the ___ as the amount borrowed by the government during the year.

Answer 8

same

Question 9

Borrowing by the government increases the what?

Answer 9

stock of government debt.

Question 10

What is the budget deficit equation?

Answer 10

Budget Deficit = ΔD = (G + i x D) − T

Question 11

The primary budget deficit is the ___ between the government’s overall budget deficit and its debt-service payments.

Answer 11

difference

Question 12

What is the primary budget deficit equation?

Answer 12

Primary budget deficit = G - T

Question 13

The primary budget surplus or deficit shows what?

Answer 13

The extent to which current tax revenues can cover the government’s current program spending.

Question 14

What is fiscal policy?

Answer 14

It is the use of government spending and
tax policies.

Question 15

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

Answer 15

rises
falls
falls
rises

Question 16

The budget deficit function is a relationship that what?

Answer 16

Plots the government’s budget deficit as a function of the level of real GDP.

Question 17

What does fiscal policy determine?

Answer 17

The position of the budget deficit function

Question 18

Changes in real GDP lead to movements along a what?

Answer 18

Given budget deficit function.

Question 19

For given government purchases and debt-service payments, there is what kind of relationship?

Answer 19

A negative relationship between real GDP and the government budget deficit.

Question 20

When real GDP = Y*, there is no ___ component to the budget deficit

Answer 20

cyclical

Question 21

Whatever deficit then exists is the ___

Answer 21

structural budget deficit

Question 22

During recessionary gaps (Y < Y*), the actual budget deficit ___ the structural budget deficit.

Answer 22

exceeds

Question 23

During inflationary gaps (Y > Y*), the actual budget deficit is ___ the structural budget deficit.

Answer 23

less than

Question 24

Changes in the stance of fiscal policy are best identified by the resulting change in the ___ budget deficit.

Answer 24

structural

Question 25

What is the equation for the change in the debt-to-GDP ratio?

Answer 25

Δd = x + (r − g) x d d is the debt-to-GDP ratio Δd is the change in the debt-to-GDP ratio x is the government's primary budget deficit as a percentage of GDP r is the real interest rate on government bonds g is the growth rate of real GDP

Question 26

What are the 2 separate forces that tend to increase the debt-to-GDP ratio?

Answer 26

1. If r exceeds g, the debt-to-GDP ratio will rise because the debt accumulates at a faster rate than GDP grows. 2. If the government has a primary budget deficit, the debt- to-GDP ratio will rise because the government is incurring new debt to finance its program spending.

Question 27

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 what?

Answer 27

Primary budget surpluses

Question 28

What may government budget deficits do?

Answer 28

They may crowd out private-sector activity and may harm future generations by reducing the economy's long-run growth rate

Question 29

What is crowding out?

Answer 29

It is the offsetting reduction in private expenditure caused by the rise in interest rates that follows an expansionary fiscal policy.

Question 30

What may budget surpluses do?

Answer 30

They may crowd in private-sector activity and be beneficial to future generations by increasing the economy’s long-run growth rate

Question 31

What is an increased budget deficit assumed to cause in the supply of national saving?

Answer 31

It is assumed to decrease the supply of national saving

Question 32

What does a decrease of national saving do to the equilibrium real interest rate? To the amount of investment?

Answer 32

It increases the equilibrium real interest rate and decreases the amount of investment

Question 33

What does a government budget deficit attract in an open economy?

Answer 33

It attracts foreign financial capital and appreciates domestic currency

Question 34

What is the long-run result of the government budget deficit in an open economy?

Answer 34

Crowding out of net exports

Question 35

The larger the increase in potential output caused by fiscal expansion the ___ private expenditure will be crowded out

Answer 35

less

Question 36

An increase in the budget deficit is assumed to cause what kind of reduction?

Answer 36

A reduction in the supply of national saving

Question 37

What will a reduction in national saving increase?

Answer 37

It will increase the equilibrium real interest rate and reduce the amount of investment in the economy

Question 38

For a closed economy, the long-run effects of an increase in the budget deficit will be a higher what?

Answer 38

Real interest rate and a reduction in private investment.

Question 39

In an open economy, the government budget deficit attracts what and appreciates what?

Answer 39

Foreign financial capital Domestic currency

Question 40

The larger the increase in potential output caused by fiscal expansion, the ___ private expenditure will be crowded out

Answer 40

less

Question 41

Government debt generates a redistribution of ___ away from future generations toward the current generations.

Answer 41

Resources

Question 42

Debt incurred to finance public investment may result in no ___ for future generations

Answer 42

burden

Question 43

Fears of future debt monetization will likely lead to expectations of future ___ and put upward pressure on ___ rates and on some prices and wages.

Answer 43

inflation nominal interest rates

Question 44

In the absence of any current actions by the central bank, a large government debt may lead to the expectation of future ___, hampering the task of the central bank in keeping inflation and inflationary expectations low.

Answer 44

inflation

Question 45

Having fiscal expansions during recessions and fiscal contractions during booms is

Answer 45

counter-cyclical fiscal policy.

Question 46

A large and rising stock of government debt could “___” of the government in times when it would otherwise want to conduct counter-cyclical fiscal policy.

Answer 46

tie the hands

Question 47

An annually balanced budget would ____ the automatic fiscal stabilizers and accentuate the swings in real GDP.

Answer 47

eliminate

Question 48

Balancing the budget over the course of the business cycle is in principle a desirable means of reconciling short-term ___ with long-term fiscal ___

Answer 48

stabilization prudence

Question 49

Most economists view a low and relatively stable debt- to-GDP ratio as the ___ indicator of fiscal prudence.

Answer 49

appropriate

Question 50

Their view permits a budget deficit such that the stock of debt grows ___ than GDP.

Answer 50

no faster