chapter 31

Question 1

the government budget constraint

Answer 1

Government Expenditure

= Tax Revenue + Borrowing

Question 2

what are government expenditures composed of?

Answer 2

• purchases of goods and services = G
• debt-service payments = i x D
• transfers

Question 3

What is the detailed formula for the government’s budget constraint?

Answer 3

G + i x D = T +Borrowing

(G + i x D) – T = Borrowing

Question 4

gov’s annual budget deficit

Answer 4

• the government’s borrowing

* also the change in the stock of debt

Question 5

budget deficit formula

Answer 5

Budget Deficit =change in D = (G + i x D) – T

Question 6

if there’s a budget deficit –> the debt _____

Answer 6

rises

Question 7

if there’s a budget surplus –> the debt _____

Answer 7

falls

Question 8

primary budget deficit (non-interest part of the budget) formula

Answer 8

Primary Budget
Deficit = Total Budget Deficit – Debt-service Payments
= (G + i x D – T) – i x D
= G – T

**Shows the extent to which current tax revenues can cover the government’s current program spending

Question 9

fiscal policy

Answer 9

use of the government’s tax and spending policies in an effort to influence the level of GDP

Question 10

for a given set of tax and spending policies, the budget deficit is ________ related to real GDP

Answer 10

negatively

the budget deficit function shows this negative relationship between the deficit and Y

Question 11

budget deficit function is ________

Answer 11

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

Question 12

________ determines the position of the budget deficit function

Answer 12

fiscal policy

Question 13

_________ lead to movements along a given budget deficit function

Answer 13

changes in real GDP

Question 14

when real GDP equals Y*, there is no ______ component to the budget deficit

Answer 14

cyclical

Question 15

what deficit exists when real GDP equals Y*

Answer 15

structural budget deficit

The structural budget deficit is sometimes called the cyclically
adjusted deficit

Question 16

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

Answer 16

exceeds

Question 17

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

Answer 17

less than

Question 18

changes in the stance of fiscal policy are best identified by the resulting change in the __________

Answer 18

structural budget deficit

Question 19

the expression that related the government budget deficit to the change in the debt-to-GDP is

Answer 19

change in d = x + (r – g) x d

d is the debt-to-GDP ratio

change in d 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 20

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

Answer 20

1. If the real interest rate exceeds the growth rate of real GDP, 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-toGDP ratio will rise because the government is incurring new debt to finance its program spending.

Question 21

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 __________

Answer 21

primary budget surpluses

Question 22

Government budget deficits may _________ private-sector activity and may harm future generations by reducing the economy’s long-run growth rate.

Answer 22

crowd-out

Question 23

def. crowding out

Answer 23

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

Question 24

Budget surpluses may _______ private-sector activity and be beneficial to future generations by increasing the economy’s long-run growth rate.

Answer 24

crowd in

Question 25

An _______ in the budget deficit is assumed to cause a reduction in
the supply of national saving

Answer 25

increase

Question 26

A ________ in the supply of national saving will increase the equilibrium real interest rate and reduce the amount of investment in the economy

Answer 26

reduction

Question 27

For a closed economy, the longrun effects of an increase in the
budget deficit will be a _______ real interest rate and a ______
in private investment

Answer 27

higher; reduction

Question 28

in an open economy, the government budget deficit ________ foreign financial and ________ the domestic currency

the long-run result is ______ of net exports

Answer 28

attracts

appreciates

crowding out

Question 29

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

Answer 29

less

Question 30

Government debt generates a ________ of resources away from future generations toward the current generations.

Answer 30

redistributions

Question 31

Whether there is a burden on future generations depends on the __________

Answer 31

nature of the government spending being financed by the deficit.

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

Question 32

Does Government Debt Hamper Economic Policy?

Monetary Policy

Answer 32

• consider a very high debt-to-GDP ratio
• creditors may come to expect monetization of debt
–> an increase in inflation expectations
–> makes monetary policy more difficult

Question 33

Does Government Debt Hamper Economic Policy?

Fiscal Policy

Answer 33

• governments often try to implement counter-cyclical fiscal policy
• deficits in recessions and surpluses in booms
• but a high debt-to-GDP ratio may restrict the government severely
–> may be unable to have stabilizing fiscal policy

Question 34

formal fiscal rules to prevent excessive build-up of debt (possibilities)

Answer 34

1. Annually Balanced Budgets

A requirement to have a balanced budget every year would lead to pro-cyclical fiscal policy.

2. Cyclically Balanced Budgets

An alternative is to require that the government’s budget be
balanced over the course of a full economic cycle.

Desirable in principle, but very difficult to define and implement.

3. Allowing for growth

Another problem with any formal fiscal rule is the emphasis on the
overall budget deficit:
- but the debt-to-GDP ratio is probably more important

Some economists view a stable (or falling) debt-to-GDP ratio as the appropriate indicator of fiscal prudence. This view permits a deficit
as long as the stock of debt grows no faster than GDP.