Fiscal Policy

Question 1

In the 3E Model, what is the effect of using fiscal policy when the economy is at vs below equilibrium?

Answer 1

In an economy with spare capacity, the government can boost aggregate demand and raise output.

In an economy with output at equilibrium, if the central bank keeps the real interest
rate unchanged in the face of the government’s expansionary fiscal policy, the economy ends with inflation bias and higher government debt

Question 2

What is the Balanced Budget multiple?

Answer 2

change y / change G = 1

Occurs if fully tax financed (assume those taxes and those benefiting have same mpc)

Question 3

What are 5 factors that affect the multipler

Answer 3

1) developed = larger
2) closed = larger
3) fixed = larger
4) high debt countries = can be negative to to higher risk of sovereign debt or exchange rate crises
5) recession = generally higher

Question 4

How doe higher automatic stabilisers affect the IS curve

Answer 4

Less responsive to changes

Steeper IS curve which shifts to a lesser degree

Question 5

What is the cyclically adjusted budget deficit?

Answer 5

the budget deficit that would prevail
given existing tax and transfer commitments if the economy was operating at equilibrium
output.

G(ye) - T (ye) = (G - t) - a (ye - yt)

Question 6

What is the Budget Identity?

Answer 6

G + it* Bt-1 = Tt + change Bt + change Mt

expenditure + interest = tax revenue + new bonds + new money

Question 7

What is the debt dynamics equation?

Answer 7

change b = d + (r - gammay)b

change debt to GDP = primary deficit + (real interest rate - real GDP growth) * exiting ratio

Question 8

What happens when there is uncertainty as to whether a government can repay its debt?

Answer 8

higher rate of borrowing to account for this (risk premium)

This feeds back into a worse debt burden (higher r in the debt dynamics equation)

Worst case, gov is cut off and finances through monetising the debt