Fiscal Policy and Government Debt

Question 1

Government debt has risen considerably in recent years in advanced countries like Australia, the US, Japan, UK, and parts of the European region. List five factors that have contributed to the increase in these Government debt loads? (5 marks)

Answer 1

1. recessions have reduced govt tax take and also increased outlays (unempl benefits)
2. costs assoc w/ supporting banks & cos during GFC
3. discretionary actions to support economies in recession after GFC (large effect)
4. previously higher debt load and servicing costs
5. rising cost due to ageing population, increased social security, rising medical costs.

Other: Increased use of Fiscal Policy to stimulate growth during a downturn; 2. discretionary FP used as a major countercyclical tool to support agg demand; 3. Capital injections, government deposit and debt guarantees, bank rescue packages; 4. impact of automatic stabilisers (spending on unemployment benefits, tax revenues follow business cycle); 5. Note FP often more permanent - implying public debt creeps upwards. Also, easing bias (tend to cut taxes more in downturn than increase in upturn - not symmetrical

Question 2

What options/policies do highly indebted Governments utilise to stabilise their debts and to restore strong growth and financial stability?

Answer 2

?

Macroprudential, variable: - countercyclical capital buffers, LTV ratios, forward looking provisioning, with flexible parameters Macroprudential, fixed: - gross leverage ratios, core funding ratios, that are NOT adjusted during the course of the cycle

Question 3

What are the key impacts on bond yields and exchange rates of a country with excessive government debt?

Answer 3

Depends who owns the debt but…

Bond Yields highand exchange rate low

Question 4

Some argue Ricardian Equivalence is a constraint on Governments over-spending. Explain this constraint (3 marks). Provide a recent example from Australia where Ricardian Equivalence didn’t hold. (1 mark)

Answer 4

Ricardian equivalence says a government cannot stimulate consumer spending since people assume that whatever is gained now will be offset by higher taxes due in the future. Australia traditionally has high debt and it had little effect on public savings