chapter 31 Flashcards
the government budget constraint
Government Expenditure
= Tax Revenue + Borrowing
what are government expenditures composed of?
- purchases of goods and services = G
- debt-service payments = i x D
- transfers
What is the detailed formula for the government’s budget constraint?
G + i x D = T +Borrowing
(G + i x D) – T = Borrowing
gov’s annual budget deficit
- the government’s borrowing
* also the change in the stock of debt
budget deficit formula
Budget Deficit =change in D = (G + i x D) – T
if there’s a budget deficit –> the debt _____
rises
if there’s a budget surplus –> the debt _____
falls
primary budget deficit (non-interest part of the budget) formula
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
fiscal policy
use of the government’s tax and spending policies in an effort to influence the level of GDP
for a given set of tax and spending policies, the budget deficit is ________ related to real GDP
negatively
the budget deficit function shows this negative relationship between the deficit and Y
budget deficit function is ________
a relationship that plots, for a given fiscal policy, the government’s budget deficit as a function of the level of real GDP
________ determines the position of the budget deficit function
fiscal policy
_________ lead to movements along a given budget deficit function
changes in real GDP
when real GDP equals Y*, there is no ______ component to the budget deficit
cyclical
what deficit exists when real GDP equals Y*
structural budget deficit
The structural budget deficit is sometimes called the cyclically
adjusted deficit
During recessionary gaps (Y < Y*), the actual budget deficit _______ the structural budget deficit.
exceeds
During inflationary gaps (Y > Y*), the actual budget deficit is ________ the structural budget deficit.
less than
changes in the stance of fiscal policy are best identified by the resulting change in the __________
structural budget deficit
the expression that related the government budget deficit to the change in the debt-to-GDP is
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
What are the two forces that tend to increase the debt-to-GDP ratio?
- 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.
- 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.
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 __________
primary budget surpluses
Government budget deficits may _________ private-sector activity and may harm future generations by reducing the economy’s long-run growth rate.
crowd-out
def. crowding out
the offsetting reduction in private expenditure caused by the rise in interest rates that follows an expansionary fiscal policy
Budget surpluses may _______ private-sector activity and be beneficial to future generations by increasing the economy’s long-run growth rate.
crowd in
An _______ in the budget deficit is assumed to cause a reduction in
the supply of national saving
increase
A ________ in the supply of national saving will increase the equilibrium real interest rate and reduce the amount of investment in the economy
reduction
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
higher; reduction
in an open economy, the government budget deficit ________ foreign financial and ________ the domestic currency
the long-run result is ______ of net exports
attracts
appreciates
crowding out
the larger increase in potential output caused by fiscal expansion, the _______ private expenditure will be crowded out
less
Government debt generates a ________ of resources away from future generations toward the current generations.
redistributions
Whether there is a burden on future generations depends on the __________
nature of the government spending being financed by the deficit.
Debt incurred to finance public investment may result in no burden for future generations.
Does Government Debt Hamper Economic Policy?
Monetary Policy
• 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
Does Government Debt Hamper Economic Policy?
Fiscal Policy
• 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
formal fiscal rules to prevent excessive build-up of debt (possibilities)
- Annually Balanced Budgets
A requirement to have a balanced budget every year would lead to pro-cyclical fiscal policy.
- 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.
- 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.
