Government expenditures & public debt Flashcards
Debt: Definition
is a stock of what the government owes as a result of past deficits
Deficit: definition
is a flow - how much the government borrows during a given year
Inflation-adjusted deficit
the correct measure of the deficit
Deficit: calculation
Deficit = G - (Tax - TR)
G : government spending
tr : transfers
Tax : total taxes
government budget constraint with a balance budget each period (no debt)
Gt + Vt = Tt + Mt − Mt−1/Pt
real purchases + real transfers = real taxes + real revenue from money creation
If the government runs a deficit, government debt increases as …
the government borrows to fund the part of spending in excess of revenues
If the government runs a surplus, government debt decreases as…
the government uses the budget surplus to repay part of its outstanding debt
primary deficit: calculation
The difference between spending and taxes, Gt - Tt
primary surplus: calculation
Tt- Gt
The government budget constraint: money supply does not change over time
Mt −Mt−1/Pt =0 –> Gt + Vt = Tt
Budget deficit
Bt+1 − Bt = Gt + Vt+rtBt − Tt
gouvernement budget constraint :
Gt +rBt =Tt +(Bt+1 −Bt)
debt-to-GDP ratio: definition
the ratio of debt to output
The change in the debt ratio over time (the left side of the equation) is equal to the sum of two terms:
- The first term is the difference between the real interest rate and the growth rate, times the initial debt ratio
-The second term is the ratio of the primary deficit to GDP
debt-to-GDP ratio: calculation
Bt/Yt -Bt-1/Yt-1 =(r-g) Bt-1/Yt-1 +Gt -Tt/Yt
the ratio of the primary deficit to GDP is equal to zero, what does happen ?
debt increases or decreases depends on whether the interest rate is positive or not
debt-to-GDP ratio increases or decreases depending on ?
the interest rate is larger or smaller than the growth rate
increase in the ratio of debt to GDP will be larger:
- the higher the real interest rate,
- the lower the growth rate of output
- the higher the initial debt ratio
- the higher the ratio of the primary deficit to GDP
Under the Ricardian equivalence proposition
- a long sequence of deficits and the associated increase in government debt are no cause for worry
- As the government is dissaving, the argument goes, people are saving more in anticipation of the higher taxes to come.
- The decrease in public saving is offset by an equal increase in private saving. Total saving is therefore unaffected, and so is investment.
- The economy has the same capital stock today that it would have had if there had been no increase in debt. Therefore, high debt is no cause for concern
No matter when taxes will be increased, the government budget constraint still implies …
that the present value of future tax increases must always be equal to the decrease in taxes today.
future tax increases appear more distant and their timing more uncer
tain, consumers are in fact more likely
to ignore them
–> because they expect to die before tax go up or they don’t think far into the future
In the short run: larger deficits are likely to lead to?
higher demand and higher output
In the long run
higher government debt lowers capital accumulation and, as a result, lowers output
long-run adverse effects on capital accumulation
adverse effects on output, does not imply that fiscal policy should not be used to reduce output fluctuations
How to measure the deficit ?
conomists have constructed deficit measures under existing tax and spending rules, if output were equal to potential output
full-employment deficit, the midcycle deficit, the standardized employment deficit, and the structural deficit (the term used by the OECD: what is it ?
deficit measures
The cyclically adjusted deficit
It measures the deficit adjusted for the economy’s cyclical position, removing the effects of temporary fluctuations in output
If the actual deficit is large but the cyclically adjusted deficit is zero, then current fiscal policy is..
consistent with no systematic increase in debt over time
The debt will increase as long as output is below the potential level of
output
if output returns to potential(after that the output is below the potential level of output) :
the deficit will disappear and the debt will stabilize
goal of fiscal policy should be to maintain a cyclically adjusted
deficit equal to zero at all times.
In a recession, the government may want to run a deficit large enough that even
cyclically adjusted deficit is positive
cyclically adjusted deficit is positive provides a useful warning: that the return of output to potential will not be enough to stabilize…
the debt
The government will have to take specific measures to stabilize the debt like :
tax increases to cuts in spending, to decrease the deficit at some point in the future
cyclically adjusted deficit are constructed: in how much steps
2
What is the first step in constructing a cyclically adjusted deficit?
- determine if a decrease in output, which leads to a decrease in revenues and not much change in spending, naturally leads to a larger deficit.
What happens to the deficit ratio if output is 5% below potential?
If output is, say, 5% below potential, the deficit as a ratio to GDP will be about 2.5% larger than if output were at potential
Why does a recession naturally lead to a larger deficit?
Recessions reduce output, leading to lower tax revenues and relatively stable government spending, which increases the deficit
What is the economic term for the effect where a recession increases the deficit and leads to fiscal expansion?
Automatic stabilizer
What is the second step of a cyclically adjusted deficit?
that potential output is the output level that would be produced if the economy were operating at the natural rate of unemployment. Too low an estimate of the natural rate of unemployment will lead to too high an estimate of potential output and therefore too optimistic a measure of the cyclically adjusted deficit.
Wars lead to large increases
in government spending
Tax smoothing
implies running large deficits when government spending is exceptionally high and small surpluses the rest of the time
Why is it feasible to reduce the debt-to-GDP ratio slowly in the current economic environment?
Low real interest rates, which are below the growth rate, allow the government to run limited primary deficits while still reducing the debt-to-GDP ratio over time.
How does the U.S. debt-to-GDP ratio compare historically, and why is it significant?
–> The US debt-to-GDP ratio is high and slowly increasing over time
–> the likely increases in spending in the future, it would be desirable to reduce primary deficits and reduce the debt ratio. Low interest rates, and by implication the low cost of debt, imply that it can be done slowly. And because low interest rates, together with the zero lower bound, put sharp limits on the use of monetary policy, they also imply that it has to be done slowly so as to avoid a decrease in demand and output.
primary deficit
the difference between government spending and government revenue, excluding interest payments on existing debt
