Week 10: Fiscal Challenges in the Long-Run

Question 1

Government Budget Constraint

Answer 1

Question 2

Budget Balance Equation

Answer 2

tax revenues - spending

Question 3

Budget Surplus

Answer 3

occurs when government income exceeds expenditures

Question 4

When does a budget deficit occur?

Answer 4

occurs when government expenditures exceed income

Question 5

Balanced Budget

Answer 5

total government spending = government tax receipts

Question 6

Gov Spending and Revenue Over Time

WW2, US and Europe

Answer 6

WW1: taxes and spending increased sharply
US: after war spending and revenue were stable fraction of GDP, budget deficits emerged 1970s
EU: welfare state building increased deficits overtime

Question 7

Debt-GDP Ratio Definition

Answer 7

measures gross debt of the general government as a % of GDP

Question 8

Debt-GDP Ratio Equation

Answer 8

Question 9

When considering the consequence of deficits and debts, what must the government consider?

Answer 9

1. Economic growth
2. Possibility of high inflation
3. Intergenerational equity
4. Extent to which deficits crowd out investments

Question 10

What limits the amount the government can borrow?

Answer 10

• Amount it can credibly be expected to pay back

- Partially how large the economies GDP to debt ratio is

Question 11

What happens if the debt-ratio becomes too high?

Answer 11

Lenders worry about the gov to repay and investors demand higher interest rates

Question 12

What happens if lenders stop lending to the government?

Answer 12

Gov may print more money to satisfy budget which generates inflation - quantitative easing

Question 13

Government Debt

Answer 13

financial liabilities of the government sector

Question 14

Net Gov Debt

Answer 14

comprises all financial liabilities minus all financial assets of the general government

Question 15

Default

Answer 15

the failure to make required interest or principal repayments on a debt

Question 16

Generational Accounting

Answer 16

the method of measuring the fiscal burdens facing current and future generations

Question 17

Example of generational accounting (WW2)

Answer 17

The fighting generation made large sacrifices, future generations benefited from the victory but paid for the war

Question 18

National Income Identity Definition

Answer 18

amount received as national income is identical to the amount spent as national expenditure, which is also identical to what is produced as national output

Question 19

National Income Identity

Answer 19

Y = C + I + G + (EX-IM )

Y = output 
C = consumption 
I = investment 
G = Government spending 
EX = exports 
IM = imports

Question 20

What can investment be financed through? (3)

Answer 20

1. Savings from private sector
2. Gov saving
3. Saving by foreigners

Question 21

Disposable Income

Answer 21

amount of money available for spending or saving after paying direct taxes

Question 22

Crowding Out

Answer 22

economic theory arguing that rising public sector spending drives down or even eliminates private sector spending

Question 23

What does Ricardian Equivalence Imply?

Answer 23

Holding PV of gov spending constant, the timing of taxes does not affect consumption
Budget deficits need to crowd out investment

Question 24

What is the Debt-GDP ratio used for?

Answer 24

Key indicator for the sustainability of gov finance

Question 25

Equation that explains the evolution of gov debt

Answer 25

Question 26

Equation that explains the evolution of Debt-GDP ratio

Answer 26

where g = growth rate of GDP

Question 27

Primary Balance definition

Answer 27

Difference between Gov revenue and its non-interest expenditure (spending, not including debt)

Question 28

How to calculate the primary balance?

Answer 28

Gov spending - taxes