16-17 Flashcards
(12 cards)
What does the term public deficit refer to?
The term public deficit refers to expenditure minus income of the public sector.
Depending on what perspective we have of the GDP the answer to how big the public sector is could differ
Production side - value added
Income side - labor and capital. Expenditure side - Y = C + G + I + NX
What is the government budget constraint?
Gt + rDt = Tt + △Dt + 1
Gt: Government consumption and government investment
r: real interest rate
D: Net debt of the government at the start of year t
Tt = net taxes : tYt (tao) - tr (tax income minus transfers)
△Dt + 1: Debt increase when we borrow more, the change in debt. Dt+1 - Dt. What the government borrows during t.
We can solve for how much the government needs to borrow.
△Dt + 1 = (Gt - Tt) + rDt
The parentaties: primary deficit, if G > T we need to borrow money
Interest payment
Do lower taxes make us richer?
Lower taxes today means higher taxes tomorrow because we still need to pay our debt.
If everyone got 100 euros from the government to finance the stimulus check, we wouldn’t actually get richer. This is because next year the tac will increase, and it is only if we have saved the 100 that we won’t have to take notice of it. But this will result in no additional demand.
This result is called Ricardian equivalence, that it doesn’t really matter if taxes are imposed now or in the future.
Explain the Ricardian equivalence
It doesn’t matter when a tax is supposed to be paid. We won’t get richer if the tax is lower today, because at some point it will get higher. It is better for politicians to reduce expenditures instead.
Assumptions about consumers
consumers have perfect access to the credit market
They face the same interest rate on borrowing and lending rate as the government
They expect to live to pay future taxes
They are forward-looking
They have full insight into the finances of the government.
Because of the assumptions the Racardian equivalence no longer seems as correct as before. However the effects of fiscal policy are hard to measure, but when government finances are in bad shape, tax reductions are a less reliable method of stimulating the economy.
What are 4 policy lags?
Sometimes fiscal policymaking takes time and a decision that is made during rescission may not take effect until after the rescission.
Four types of lags:
Information lag: time it takes for policy makers to get info about what is happening in the economy
Decision lag: the time between the observation and the point where policymakers have analyzed the situation and taken a decision
Implementation lag: Time taken by government authorities to implement a decision
Effect lag: time taken for the policy action to have an effect on economic activity
What are automatic stabilizers?
Automatic effects on the budget balance which occur without the government taking any new decisions.
Countries where taxes are higher have stronger automatic stabilizer effects.
what is the structural budget deficit?
The hypothetical deficit we would have had if GDP had been on its natural level without any policy decisions.
What is the exchange rate and the real exchange rate?
The exchange rate is a measure of competitiveness, and it is also an important determinant of AD in the open economy. It measures the price level in the country compared with the price level abroad after prices have been converted to the same currency.
Real exchange rate: the relative price between goods produced at home and abroad.
If the real interest rate increases then domestic goods become relatively more expensive. But if the nominal interest rate increases then the domestic currency becomes relatively more expensive.
The relative price of a domestically produced good is: ℰ = P/(P*/e)
What are the 2 new factors that affect aggregated demand?
foreign income and real exchange rate. When foreign income increases, AD rises in one country it will have spillover effects to neighboring countries.
What is the real excjhane rates effect o net export function? NX(ℰ, Y, T) = X(ℰ, Yd, Ye - Te, r, A) - IM (ℰ, Yd, Ye - Te, r, A)/ℰ
The real exchange rate appears in three places so there is 3 effects.
- When domestic goods become more expensive, the quantity of export decreases. Substitution effect.
- As domestic goods become more expensive, domestic consumers buy more foreign goods so the quantity of imports increases. Substitution effect.
- When import is cheaper this decreases the value of imports relative to the value of exports, and increases net exports. Valuation Effect.
The formal condition for net export to fall with an appreciation of the real exchange rate is the Marshall-Lerner condition which says that the sum of (the absolute value of) the price elasticities of import and export demand must be higher than one.
What does the interest parity condition state?
The interest parity condition says that countries with depreciating currencies must have higher interest rates to compensate for expected depreciation of the currency. The interest rate must compensate for expected changes in the exchange rates.
When we have a floating exchange rate the cemtral bank is free to set the interest rate. What variables does the exchange rate depend on now?
The exchange rate now depend on 3 variables:
The domestic interest rate
The foreign interest rate
The expected future exchange rate
et = (1+it)/(1+i*t) * eet+1
