W9P2 - Notebooklm Flashcards
Why might simply looking at tax revenue minus government spending be a misleading indicator of the fiscal stance?
Because both tax revenue and government spending typically depend on the level of income. Tax revenue rises with income and falls during recessions, while government spending on benefits moves inversely.
What is the role of GDP growth forecasts when a government announces a new budget?
All changes in the government budget need to be calculated based on future assumptions of factors like GDP growth and inflation. Organizations like the OBR in the UK provide these forecasts.
Explain the relationship between the output gap and the budget surplus as represented by the fiscal policy (FP) schedule.
The FP schedule is upward sloping. As the output gap increases (moving to the right), tax revenue increases and government spending decreases, leading to a larger budget surplus
What happens to the FP schedule during an expansionary fiscal policy?
An expansionary fiscal policy shifts the FP schedule downwards. This means that at a given output level, the budget balance will be lower (potentially a deficit instead of a surplus).
Why is it difficult to determine if a change in the actual budget balance is due to a change in fiscal policy or the business cycle?
Observing a move in the actual budget balance from one point to another doesn’t reveal whether it’s caused by a change in the government’s underlying fiscal policy or simply a positive or negative deviation from trend output (the business cycle).
What is the cyclically adjusted budget balance (or structural budget balance)?
It is a measure of what the budget balance would be if the economy were operating at its trend output level. It removes the cyclical component from the actual budget balance.
What is trend output, and why is it important for calculating the structural budget balance?
Trend output is the potential level of output in an economy. It’s crucial for calculating the structural budget balance because the structural budget balance estimates tax revenue and government spending if the economy were at this trend level. This is similar to its importance in setting interest rates using the Taylor rule.
What was a key observation regarding structural budget balances in some OECD countries during the 2008-2010 financial crisis?
While most OECD countries experienced increased cyclical budget deficits, some countries like Greece and Italy also saw an increase in their structural budget deficits, indicating a change in their underlying fiscal policy.
What is the consequence of persistent government budget deficits?
Persistent government budget deficits lead to the accumulation of public debt.
Explain why, in a scenario with no growth and no inflation, even a balanced primary budget can lead to an increasing debt burden.
Even with a balanced primary budget (government spending excluding interest equals taxes), the government still needs to make interest payments on its outstanding debt. Without economic growth or inflation, these interest payments will cause the total debt to increase.
What is the condition for stabilizing the absolute level of debt when there is no growth and no inflation?
To stabilize the absolute level of debt, the government needs to run a budget surplus (taxes minus government spending) that is equal to the interest payments on the outstanding debt.
Why is the debt-to-GDP ratio a more relevant measure for assessing debt sustainability than the absolute level of debt?
Because it takes into account the size of the economy. A larger economy can typically sustain a higher absolute level of debt.
What is the condition for the debt-to-GDP ratio to remain constant?
The primary surplus relative to GDP needs to be equal to (real interest rate - output growth rate) multiplied by the debt-to-GDP ratio.
How does a positive output growth rate affect the primary surplus required to stabilize the debt-to-GDP ratio?
If the output growth rate is positive, the primary surplus required to stabilize the debt-to-GDP ratio will be lower than what is needed to stabilize the absolute debt level.
What is “inflation tax” in the context of government debt?
Inflation tax is the reduction in the real value of government debt (which is typically issued in nominal terms) due to an increase in the general price level (inflation).
What are some ways a government can try to reduce its debt burden?
o Cutting deficits (reducing government spending, increasing taxes)
o Money creation (printing money)
o Defaulting on debt
o Financial repression (regulating interest rates, introducing capital controls)
