Chapter 17 Flashcards
what is the close relation between the deficit and the steady state debt ratio? what does it mean?
long run debt ratio = deficit/ GDP all / growth rate of nominal GDP
D/Y = ((G-T+iD)/Y)/(π+g)
means a target level for the deficit can be seen as an implicit target for the LR net debt ratio
what have reforms of budgetary procedures involved?
involved a top-down approach where the total size of spending is decided first then this spending is divided between different departments
why is delegation of fiscal policy more controversial than monetary?
fiscal policy decisions are inherently more political
what happens if the government is acting in a myopic way?
public investment in infrastructure will be too low
may be a reason to exclude net public investments when setting a limit or a target for the deficit
why may current tax and spending levels may become unsustainable in some countries?
ageing populations
state what will happen if the debt ratio is on an unsustainable path (at least one will happen)
- taxes are increased, transfers and gov spending reduced relative to GDP
- gov defaults on (or part of) the debt
- CB monetizes the debt
what are some reasons for the deficit bias?
voters dont understand the future consequences of the policy
may be myopic and credit constrained so they rationally voted for a gov’t that borrows money on their behalf and passes costs onto future generations
what will happen if politicians think the future government will waste resources? what happens if they have to compromise?
they may think better to spend the money today (run a deficit) may push for their specific interest without taking full responsibility for the consequences for the economy as a whole
what are ways to deal with the deficit bias?
set up targets for deficits and debt
meant to be relatively permanent commitments which act as constraints on day to day policy decisions
what will attempts to achieve a higher level of employment by expansionary monetary policy lead to?
situation with high inflation without any gains in employment
why may a promise to keep inflation low not be credible?
shortsighted policymaker has incentive to deviate and pursue a more inflationary policy
what does a strict norm for inflation limit?
limits possibilities for CB to help in SR stabilisation of output
why is it hard to formulate an effective rule in advance for inflation?
due to the different shocks that can occur
what is the credibility-flexibility trade off?
when we delegate monetary policy to a more conservative CBer. The less weight the leader of the CB puts on employment the more we reduce inflation bias but at the same time the CB will be less flexible in allowing temporary variations in inflation
we want to choose a CBer who puts low weight on employment
give examples of inflation reforms used by countries
explicit inflation targets
long term contracts for board members
delegation of MP to independent CB
why doesnt gov debt matter in a world with full ricardian equivalence and non distortionary taxes?
current generation will save to compensate for future generations future tax payments
what about less than full?
a deficit will redistribute income from future to current generations
what increases with tax levels? what level is preferred from an efficiency point of view?
tax distortions increases as tax increases
a stable tax is preferred to a higher or lower tax
how can high debt easily become unsustainable?
as lenders require high IRs to compensate for the risk of default
