April 9

Question 1

how can government expenditure be financed?

Answer 1

MUST be financed by either

1. TAX REVENUE
2. BORROWING

Question 2

government expenditure equation

Answer 2

gov expenditure = tax revenue + borrowing

Question 3

gov expenditures = composed of…

Answer 3

1. purchases of goods and services (G)
2. debt service payments = i x D

(interest x accumulated debt)

3. transfers (t)

Question 4

government’s budget constraint

Answer 4

(T is gov’s net tax revenues)

G + i x D = T + Borrowing

(G + i x D) - T = Borrowing

Question 5

when gov needs to borrow…

Answer 5

they’re in a BUDGET DEFICIT

revenue isn’t enough to finance everything

Question 6

when gov runs a surplus…

Answer 6

gov uses that opportunity to BUY OUTSTANDING GOV DEBT (to reduce their debt)

Question 7

positive deficit means you’re

Answer 7

borrowing

Question 8

negative deficit means you’re

Answer 8

saving

Question 9

what composes the gov’s annual budget deficit?

Answer 9

1. government’s borrowing
2. change in the stock of debt

Question 10

how can we write the gov’s budget deficit?

Answer 10

budget deficit = change in D = (G + i x D) - T

Question 11

what happens to the debt if there’s a budget deficit?

Answer 11

the debt rises

Question 12

what happens to the debt if there’s a budget surplus?

Answer 12

the debt falls

Question 13

primary budget deficit

Answer 13

the deficit on the NON-INTEREST part of the budget

primary budget deficit = total budget deficit - debt service payments

Question 14

equation for the primary budget deficit

Answer 14

= (G + i x D - T) - (i x D)
= G - T

Question 15

what does the primary budget deficit show?

Answer 15

the extent to which current tax revenues can cover the government’s current spending

Question 16

deficits and debt in Canada

Answer 16

1. large & persistent budget deficits began in mid-19970s and continued throughout 1980s and early 1990s
2. federal budget was in surplus from 1998 to 2008, but the budget returned to deficit in 2009 mostly because of the major recession
3. Covid in 2020 led to enormous increase in budget deficit - increased to about 18% of GDP (larger deficit than Canada has experienced at any time since WWII)

Question 17

stance of fiscal policy when it comes to gov debt

Answer 17

fiscal policy is use of gov’s TAX and SPENDING POLICIES in effort to influence LEVEL OF GDP

Question 18

for given set of tax and spending policies, how does the budget deficit relate to real GDP?

Answer 18

negatively

higher GDP = lower budget deficit

BUDGET DEFICIT FUNCTION shows the negative relationship between the deficit and Y

Question 19

what determines the position and slope of the budget deficit function?

Answer 19

fiscal policy

Question 20

what leads to movements along a given budget deficit function?

Answer 20

changes in real GDP

Question 21

cyclically adjusted deficit (CAD)

Answer 21

aka STRUCTURAL DEFICIT

this is the deficit adjusted for EFFECTS OF THE ECONOMIC CYCLE

it shows what the deficit would be if economy were OPERATING AT FULL POTENTIAL (Y*)

Question 22

why is the CAD useful?

Answer 22

during recessions, gov tax revenues fall and spending on things like unemployment benefits rises - this INCREASES THE DEFICIT, but not necessarily because of poor fiscal management

during booms, gov tax revenues increase and spending on things like unemployment benefits falls (the REVERSE)

so the CAD FILTERS OUT THESE TEMPORARY EFFECTS to give a CLEARER PICTURE OF GOV’S UNDERLYING FISCAL POSITION

Question 23

if Y < Y*, the budget deficit will be _______ than the CAD

Answer 23

larger

shift from B0 to B1 (upward/rightward shift) reflects a FISCAL EXPANSION

^ the CAD rises

Question 24

change in d = x + (r - g) x d

Answer 24

d = dept-to-GDP ratio

x = gov’s primary budget deficit as percentage of GDP

r = real interest rate

g = growth rate of real GDP

Question 25

2 IMPLICATIONS (change in d = x + (r - g) x d)

Answer 25

1. if r > g, then d will rise unless there's a sufficient surplus 2. if r = g, then all that's required to keep d constant is a primary budget balance (T = G)

Question 26

if r > g...

Answer 26

if real interest rate is higher than the growth rate of real GDP then d (dept-to-GDP ratio) will RISE unless there's a sufficient surplus

Question 27

if r = g...

Answer 27

if real interest rate equals the growth rate of real GDP then all that's required to keep d (dept-to-GDP ratio) constant is a primary budget balance (T = G)

Question 28

Greek tragedy of Debt economics

Answer 28

2011 - Greek economy had been in recession for 3 years, unemployment rate over 20%, gov implementing deep cuts in spending to reduce overall budget deficit of 9.2% of GDP why was Greek economy cutting spending if there was a deep recession?

Question 29

why was Greek economy cutting spending if there was a deep recession?

Answer 29

consider Greece's data at beginning of 2011 Greece's public debt = 143% of GDP (d = 1.43) average nominal interest rate on gov debt = 1.2% (r = 0.012) real GDP growth = -6.9% (g = -0.069)

Question 30

to stabilize the Greek debt-to-GDP ratio, we need change in d = to what?

Answer 30

to 0 using 2011 data... x* = - (r - g) d x* = (-0.012 - 0.069) x (2.43) = -0/016 means that Greece would've needed a PRIMARY BUDGET SURPLUS of 11.6% of GDP in 2011 its actual primary budget balance that year was a DEFICIT of 2.3%

Question 31

what do we assume when it comes to changes in gov's flow of saving?

Answer 31

assume they aren't offset by changes in private saving assume that CHANGES IN BUDGET DEFICIT lead to changes in NATIONAL SAVING

Question 32

crowding out

Answer 32

reduction in private expenditure caused by an expansionary fiscal policy 1. higher interest rates (investment) 2. appreciated currency (net exports) the fiscal expansion can be either: 1. increase in G 2. decrease in T

Question 33

crowding out investment - consider a closed economy at Y*

Answer 33

fiscal expansion 1) increases the deficit and 2) reduces national saving interest rates rise and investment falls

Question 34

crowding out investment - in an open economy

Answer 34

open economy - as interest rates rise, there's an INFLOW OF FOREIGN CAPITAL this capital inflow leads to an APPRECIATION OF CURRENCY and a CROWDING OUT OF NET EXPORTS if there's an increase in Y* caused by fiscal expansion, PRIVATE EXPENDITURE WILL BE LESS CROWDED OUT (think of the AE curve)

Question 35

do deficits harm future generations?

Answer 35

gov debt generates a REDISTRIBUTION of resources AWAY FROM FUTURE GENERATIONS towards the current generations whether there's a BURDEN on future gens depends on the nature of the GOV SPENDING being FINANCED BY THE DEFICIT

Question 36

what type of gov spending behind deficits may result in no burden for future generations?

Answer 36

debt incurred to finance PUBLIC INVESTMENT

Question 37

monetization of debt

Answer 37

means the central bank is FINANCING GOV DEBT through printing NEW MONEY basically, the government BORROWS money and instead of raising it from private investors, the central bank BUYS GOV BONDS

Question 38

how does the monetization of debt work?

Answer 38

1. government runs a deficit and issues bonds 2. central bank buys those bonds, often by creating new money 3. that money enters the economy (either directly or through banks) this will stimulate the economy and keep interest rates low but risk of leading to inflation

Question 39

does gov debt hamper economic policy? MONETARY POLICY

Answer 39

1. consider a very high dept-to-GDP ratio 2. creditors may come to expect MONETIZATION of debt ^ this INCREASES INFLATION EXPECTATIONS makes monetary policy harder

Question 40

does gov debt hamper economic policy? FISCAL POLICY

Answer 40

1. governments often try to implement COUNTER-CYCLICAL FISCAL POLICY to try to smooth out the economic cycle (stabilize) ^ spending increases or tax cuts during recessions ^ spending cuts or tax increases during booms 2. but a HIGH DEBT-TO-GDP RATIO may restrict the government severely ^ may be UNABLE to implement stabilizing fiscal policy

Question 41

Jan 2020 right before Covid - what was the Cad federal gov's debt-to-GDP ratio?

Answer 41

about 33% massive increase in spending during pandemic pushed debt ratio up by almost 20%

Question 42

potential problem with large public debt leads some people to consider...

Answer 42

formal fiscal rules to prevent the excessive buildup of debt

Question 43

3 possibilities for formal fiscal rules to prevent excessive debt-buildup

Answer 43

1. annually balanced budgets 2. cyclically balanced budgets 3. maintaining a prudent dept-to-GDP ratio

Question 44

annually balanced budgets

Answer 44

requirement to have a balanced budget every year leads to PRO-CYCLICAL FISCAL POLICY

Question 45

cyclically balanced budgets

Answer 45

require that the gov's budget be balanced over the course of a FULL ECONOMIC CYCLE desirable in principle, but very hard to define and implement

Question 46

maintaining a prudent debt-to-GDP ratio

Answer 46

most economists view a LOW and RELATIVELY STABLE dept-to-GDP ratio as the appropriate indicator of fiscal prudence their view permits a budget deficit such that the STOCK OF DEBT GROWS NO FASTER THAN GDP