Government expenditures & public debt

Question 1

Debt: Definition

Answer 1

is a stock of what the government owes as a result of past deficits

Question 2

Deficit: definition

Answer 2

is a flow - how much the government borrows during a given year

Question 3

Inflation-adjusted deficit

Answer 3

the correct measure of the deficit

Question 4

Deficit: calculation

Answer 4

Deficit = G - (Tax - TR)
G : government spending
tr : transfers
Tax : total taxes

Question 5

government budget constraint with a balance budget each period (no debt)

Answer 5

Gt + Vt = Tt + Mt − Mt−1/Pt

real purchases + real transfers = real taxes + real revenue from money creation

Question 6

If the government runs a deficit, government debt increases as …

Answer 6

the government borrows to fund the part of spending in excess of revenues

Question 7

If the government runs a surplus, government debt decreases as…

Answer 7

the government uses the budget surplus to repay part of its outstanding debt

Question 8

primary deficit: calculation

Answer 8

The difference between spending and taxes, Gt - Tt

Question 9

primary surplus: calculation

Answer 9

Tt- Gt

Question 10

The government budget constraint: money supply does not change over time

Answer 10

Mt −Mt−1/Pt =0 –> Gt + Vt = Tt

Question 11

Budget deficit

Answer 11

Bt+1 − Bt = Gt + Vt+rtBt − Tt

Question 12

gouvernement budget constraint :

Answer 12

Gt +rBt =Tt +(Bt+1 −Bt)

Question 13

debt-to-GDP ratio: definition

Answer 13

the ratio of debt to output

Question 14

The change in the debt ratio over time (the left side of the equation) is equal to the sum of two terms:

Answer 14

• 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

Question 15

debt-to-GDP ratio: calculation

Answer 15

Bt/Yt -Bt-1/Yt-1 =(r-g) Bt-1/Yt-1 +Gt -Tt/Yt

Question 16

the ratio of the primary deficit to GDP is equal to zero, what does happen ?

Answer 16

debt increases or decreases depends on whether the interest rate is positive or not

Question 17

debt-to-GDP ratio increases or decreases depending on ?

Answer 17

the interest rate is larger or smaller than the growth rate

Question 18

increase in the ratio of debt to GDP will be larger:

Answer 18

• 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

Question 19

Under the Ricardian equivalence proposition

Answer 19

• 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

Question 20

No matter when taxes will be increased, the government budget constraint still implies …

Answer 20

that the present value of future tax increases must always be equal to the decrease in taxes today.

Question 21

future tax increases appear more distant and their timing more uncer
tain, consumers are in fact more likely

Answer 21

to ignore them
–> because they expect to die before tax go up or they don’t think far into the future

Question 22

In the short run: larger deficits are likely to lead to?

Answer 22

higher demand and higher output

Question 23

In the long run

Answer 23

higher government debt lowers capital accumulation and, as a result, lowers output

Question 24

long-run adverse effects on capital accumulation

Answer 24

adverse effects on output, does not imply that fiscal policy should not be used to reduce output fluctuations

Question 25

How to measure the deficit ?

Answer 25

conomists have constructed deficit measures under existing tax and spending rules, if output were equal to potential output

Question 26

full-employment deficit, the midcycle deficit, the standardized employment deficit, and the structural deficit (the term used by the OECD: what is it ?

Answer 26

deficit measures

Question 27

The cyclically adjusted deficit

Answer 27

It measures the deficit adjusted for the economy’s cyclical position, removing the effects of temporary fluctuations in output

Question 28

If the actual deficit is large but the cyclically adjusted deficit is zero, then current fiscal policy is..

Answer 28

consistent with no systematic increase in debt over time

Question 29

The debt will increase as long as output is below the potential level of

Answer 29

output

Question 30

if output returns to potential(after that the output is below the potential level of output) :

Answer 30

the deficit will disappear and the debt will stabilize

Question 31

goal of fiscal policy should be to maintain a cyclically adjusted

Answer 31

deficit equal to zero at all times.

Question 32

In a recession, the government may want to run a deficit large enough that even

Answer 32

cyclically adjusted deficit is positive

Question 33

cyclically adjusted deficit is positive provides a useful warning: that the return of output to potential will not be enough to stabilize…

Answer 33

the debt

Question 34

The government will have to take specific measures to stabilize the debt like :

Answer 34

tax increases to cuts in spending, to decrease the deficit at some point in the future

Question 35

cyclically adjusted deficit are constructed: in how much steps

Answer 35

2

Question 36

What is the first step in constructing a cyclically adjusted deficit?

Answer 36

1. 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.

Question 37

What happens to the deficit ratio if output is 5% below potential?

Answer 37

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

Question 38

Why does a recession naturally lead to a larger deficit?

Answer 38

Recessions reduce output, leading to lower tax revenues and relatively stable government spending, which increases the deficit

Question 39

What is the economic term for the effect where a recession increases the deficit and leads to fiscal expansion?

Answer 39

Automatic stabilizer

Question 40

What is the second step of a cyclically adjusted deficit?

Answer 40

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.

Question 41

Wars lead to large increases

Answer 41

in government spending

Question 42

Tax smoothing

Answer 42

implies running large deficits when government spending is exceptionally high and small surpluses the rest of the time

Question 43

Why is it feasible to reduce the debt-to-GDP ratio slowly in the current economic environment?

Answer 43

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.

Question 44

How does the U.S. debt-to-GDP ratio compare historically, and why is it significant?

Answer 44

–> 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.