Tax Policy + Credit Market Imperfections

Question 1

Define Gov. Expenditure

Answer 1

Purchases of goods / services by the gov. including the gov’s own production

Question 2

What is the government’s budget deficit

Answer 2

B = G - T

Question 3

Lump Sum Tax

Answer 3

Amount paid does not depend on behaviour

Question 4

In the two-period model, what is tax revenue in the current period and future period?

Answer 4

T=Nt (Current)

T^I=Nt^I (Future)

Question 5

In the future period, what formula represents the amount that the government has to repay?

Answer 5

(1+r)B

Question 6

What is the government’s budget constraint in the future period?

Answer 6

T^1 - G^1 = (1+r)B

Question 7

What’s the implied constraint on bond issuance

Answer 7

B =( T(^1) - G(^1)) / 1+ r

Question 8

What is the present value constraint for the government (using B = G-T)

Answer 8

T + T^1 / 1+r = G + G^1 / 1+r

Question 9

What is Ricardian Equivalence?

Answer 9

The argument that the gov. tax policy has no power to affect aggregate demand.
- says that if government increases households’ current disposable income by cutting taxes, households will not spend this extra income

WHY? a tax cut causes the budget deficit to increase leading to more government debt, the more government debt, the higher future taxes will need to be to pay back the debt

Question 10

What are the three (Strong) assumptions of ricardian equivalence?

Answer 10

1) lump sum taxes
2) households equally share the tax burden
3) no credit-market imperfections

Question 11

What are two implications of a binding borrowing constraint?

Answer 11

1) no consumption smoothing following a temporary increase or decrease in disposable income
2) failure of Ricardian equivalence (deficit financed tax cut increases current cons. spending)

Question 12

DEF: Interest Rate Spread

Answer 12

Difference between two interest rates