Chapter 16 Flashcards
1
Q
how are gov expenditures financed?
A
(same as individual’s expenditures are)
- borrowing
- income (tax revenue)
2
Q
government’s budget constraint in words
A
gov expenditure = tax revenue + borrowing
3
Q
3 categories of gov expenditure
A
- good and services (G)
- debt service payments (i x D)
- transfers
4
Q
debt service payments
A
interest payments on OUTSTANDING STOCK OF DEBT
i x D
i = interest rate
D = stock of gov debt
5
Q
transfers
A
(3rd category of gov spending)
transfers to individuals and firms
ie. employment insurance benefits, public pensions, industrial subsidies
6
Q
we include transfers as part of…
A
T
(net tax revenue aka tax revenue minus transfers)
7
Q
government’s budget constraint algebraically
A
G + i x D = T + Borrowing
OR
(G + i x D) - T = Borrowing
8
Q
(G + i x D) - T = Borrowing — this equation says what?
A
says that any excess of government spending (G + i x D) over net tax revenues (T) must be financed by gov borrowing
9
Q
gov’s annual budget deficit
A
any shortfall of current revenue below current expenditure
10
Q
recall: how does the government borrow?
A
by issuing bonds and selling them to lenders
11
Q
what does borrowing by the government do?
A
increases the stock of GOVERNMENT DEBT
12
Q
government debt
A
outstanding stock of financial liabilities for the government
equal to the accumulation of past budget deficits
13
Q
D
A
outstanding stock of government dept
14
Q
change in D
A
change in the stock of debt during the course of the year
15
Q
how can we write the budget deficit?
A
change in D = (G + i x D) - T
16
Q
government’s annual budget deficit is WHAT? and what is it ALSO EQUAL TO?
A
it’s the EXCESS OF EXPENDITURE OVER TAX REVENUES in a given year
it’s also equal to the CHANGE IN STOCK OF GOV DEBT during the year
17
Q
for given tax revenues, a smaller deficit can only come about…
A
through a reduction in government expenditures
if T is constant, lowering G is needed for a smaller deficit
18
Q
for given expenditures, a smaller deficit can only come about…
A
through increasing tax revenues
19
Q
what happens to the stock of gov debt whenever the budget deficit is positive?
A
it rises
20
Q
budget deficit _______ the stock of government debt and a budget surplus _______ it
A
budget deficit INCREASES stock of gov debt
budget surplus DECREASES stock of gov debt
21
Q
what component of total gov expenditures is out of the control of the current gov?
A
the debt-service payments (i x D)
because this is determined by PAST gov borrowing
therefore can’t be influenced by gov policy
22
Q
what components of total gov budget are controllable by immediate gov?
A
G and T
attributable to current spending and tax policies
23
Q
primary budget deficit
A
the difference between the government’s overall budget deficit and its debt-service payments
primary budget deficit = G - T
24
Q
what does primary budget deficit show?
A
the extent to which CURRENT TAX REVENUES are sufficient to finance expenditure on current gov programs
25
if G - T = -$8.2 billion
then the gov has a primary budget surplus of $8.2 billion for that year
so total tax revenues were more than sufficient to cover the gov's program spending
(but doesn't mean they were sufficient to cover their debt service payments - i x D)
26
what does a deficit imply about the stock of gov debt?
implies the stock of gov debt is rising
27
when examining the size and effects of budget deficits/surpluses, you must consider all...
all levels of government
federal, provincial, territorial and municipal
28
can we fully attribute changes in the budget deficit to changes in gov's fiscal policy?
no - only some changes in budget deficit are due to changes in gov's fiscal policy
others = result of changes in level of economic activity (GDP)
29
how can we distinguish between effects on the budget deficit that come from 1) change of fiscal policy or 2) change in economic activity (GDP)?
use the BUDGET-DEFICIT FUNCTION
helps us see how budget deficit can rise/fall even with no change in fiscal policy
30
budget deficit
budget deficit = (G + i x D) - T
31
what does level of net tax revenues (T) depend on?
typically depends on the level of real GDP
higher GDP = higher tax revenues
higher GDP = fewer transfers (less welfare and unemployment insurance)
so net tax revenues (T) increase when GDP increases
32
are gov purchases and debt service payments independent of the level of GDP?
more or less, yes they are
(unlike T)
33
with no changes in gov's fiscal policies, budget deficit will tend to...
increase in recessions
decrease in booms
(because G and i x D don't vary with GDP, and T does)
34
for a given set of expenditure and taxation policies, budget deficit rises as real GDP...
falls
and budget deficit falls as real GDP rises
35
what determines the position of the budget deficit function?
the expenditure and taxation policies of the government
1. more EXPANSIONARY POLICY (ie. increase in G) shifts the budget deficit function UPWARDS
2. more CONTRACTIONARY POLICY (ie. decrease in G) shifts function DOWNWARDS
3. ABSENCE OF POLICY CHANGE represents a MOVEMENT ALONG the function
^ thus, for a given set of fiscal policies, budget deficit will decrease when GDP increases
36
what results in a movement along a given budget deficit function?
changes in real GDP
37
what shifts a budget deficit function?
changes in fiscal policy (G and T)
expansionary policy increases deficit (shifts curve up)
contractionary policy decreases deficit (shifts curve down)
38
what is the actual budget deficit a sum of at any given time?
1. the structural deficits
2. the cyclical deficits
39
structural deficit
the amount of the deficit that's due to the UNDERLYING DESIGN OF FISCAL POLICY
this is independent of current GDP levels
40
cyclical deficit
the amount of the deficit that's due to actual GDP being either ABOVE or BELOW POTENTIAL GDP
cyclical deficit is zero when real GDP = Y*
41
when is there no cyclical component to the budget deficit?
when real GDP = Y*
whatever deficit exists here is STRUCTURAL
42
what is the structural budget deficit sometimes called?
the CYCLICALLY ADJUSTED DEFICIT (CAD)
43
why do we call it the cyclically adjusted deficit?
because in order to measure the structural deficit we estimate what the budget deficit would be with CURRENT POLICIES IN PLACE but in hypothetical that Y = Y*
44
during recessionary gaps (Y < Y*), the ACTUAL budget deficit ________ the structural budget deficit
exceeds
the cyclical component is positive
45
during inflationary gaps (Y > Y*), the ACTUAL budget deficit _______ the structural budget deficit
is less than
the cyclical component is negative
46
how can we best identify a change in the stance of fiscal policy?
we can't simply examine the change in the budget deficit - because the deficit will change whenever Y changes
even in the absence of a change in fiscal policy
47
a change in the _______ deficit reveals a change in fiscal policy
structural
expansionary fiscal policy shifts budget deficit function upwards (increases the structural deficit)
contractionary fiscal policy shifts budget deficit function downwards (decreases the structural deficit)
48
can the structural deficit be measured exactly? what about the actual budget deficit?
structural budget deficit CANNOT be measured directly (only estimated)
the actual budget deficit can be
49
why can't we directly measure the structural budget deficit?
because its value depends on value of potential GDP (Y*) and this is not directly observable
50
difference between the actual budget deficit and the structural budget deficit reveals what?
reveals the LEVEL OF OUTPUT COMPARED TO POTENTIAL
51
when is the actual budget deficit above the structural budget deficit?
when output is below potential
52
when is the actual budget deficit above the structural budget deficit?
when output is above potential
53
to gauge importance of gov deficits and debt, they should be considered relative to what?
to the SIZE of the economy
where the debt-to-GDP ratio comes in
54
algebra that relates the gov's primary budget budget deficit to the change in the debt-to-GDP ratio
change in d = x + (r - g) x d
d = debt-to-GDP ratio
x = primary budget deficit (as % of GDP)
r = interest rate
g = growth rate of real GDP
55
change in d = x + (r - g) x d
^ two forces shown by this equation
1. if real interest rate exceeds the growth rate of real GDP (if r exceeds g), then the debt-to-GDP ratio will rise
^ because debt is accumulating faster than GDP is growing
2. if gov has a primary budget deficit (x is positive), then the dept-to-GDP ratio will rise
^ because gov is incurring new debt to finance its program spending
56
if real interest rate (r) on gov debt is approximately equal to the growth rate of real GDP (x), reductions in debt-to-GDP ratio require...
the government to run primary budget surpluses
57
how can we explain the fact that the Greek gov was CUTTING SPENDING when it's economy was in a deep recession?
can use DEBT DYNAMICS to explain this
d = 1.43
r = 0.012
g = -0/069
if d is to be held constant (change in d = 0), x would need to be -0.016
this means that Greece would've needed a PRIMARY BUDGET SURPLUS OF 11.6% in order to stabilize its debt-to-GDP ratio
but it actually had a deficit of 2.3%
stabilizing d would've required a reduction in G or increase in T of roughly 14% of GDP
58
by late 2011 in Greece, what was clear to most holders of Greek gov bonds?
the debt ratio would almost certainly continue rising for several years
how would Greek gov repay the existing bonds?
demand for Greek bonds plummeted
bond yields increased
increase in bond yields made things worse - make it costlier to finance Greece's large budget deficit
greater financing costs increased the need for fiscal contraction
this reduced AD and real GDP even more
59
how did they break the vicious cycle in Greece?
Greek gov turned to IMF and EU members for SUBSTANTIAL LOANS
this would permit them to finance their budget deficit and bond rollovers for a few years
while Greece implemented its necessary fiscal adjustments and tried to restore its fiscal credibility
60
Greek resolution?
for next 5 years, Greek economy continued to shrink and gov struggled to lessen the budget deficit
contractionary fiscal policy caused primary budget to fall sharply, but the shrinking economy resulted in further increases in the gov's debt ratio
got worse with COVID
it's still not looking good
61
why should we care about size of gov deficit and its debt?
first reason: DEFICITS MAY CROWD OUT PRIVATE SECTOR ACTIVITY
^ this harms future generations by reducing the economy's long-run growth rate
second reason: SURPLUSES MAY CROWD IN PRIVATE SECTOR ACTIVITY
^ this is beneficial for future generations bc it increases economy's long run growth rate
62
when gov increases its budget deficit, it also increases its...
borrowing
and thus reduces its savings
NATIONAL SAVINGS will fall
63
in our macro model, we assume that in increase in the gov's budget deficit leads to a _______ in national ________
DECREASE in NATIONAL SAVING
64
investment in closed economies
recall: interest rate adjusts until desired investment equals desired national saving
for a closed economy, long-run effects of increase in budget deficit = a HIGHER INTEREST RATE and a REDUCTION IN PRIVATE INVESTMENT
65
in closed economies, the long-run effect of a fiscal expansion is what 3 things?
1. reduced national savings
2. increased real interest rate
3. crowding out of private investment
66
fiscal expansion - net exports in open economies
financial capital is internationally mobile
say gov increases budget deficit by increasing G or reducing T
1. real interest rate rises in CAD - attracts foreigners to higher-yield Cad assets
2. foreign financial capital flows into Cad
3. leads to increased demand for Cad dollars and thus an appreciation of the cad dollar
4. if currency appreciation = sustained over several months, it will reduce Cad's exports and increase Cad's imports (NX will fall)
5. fiscal expansion causes AD curve to shift right, but currency appreciation reduces net exports and causes AD curve to shift back left
67
in an open economy, the government budget deficit...
attracts foreign capital (because of higher interest rates)
this appreciates the domestic currency
long run result is a crowding out of NET EXPORTS (appreciated currency reduces exports and increases imports)
68
full crowding out doesn't occur if what happens?
if the level of potential output (Y*) increases as a result of the fiscal expansion
ie. suppose new gov spending is for productivity enhancing infrastructure or improvements in health/education
^ these types of expenditures will likely increase the level of Y*
^ if Y* rises, then long-run adjustment will bring economy back to a higher level of Y*
^ in this case, the fiscal expansion crowds out LESS PRIVATE EXPENDITURE
69
the extent of crowding out depends crucially on the change in what?
change in Y*
which in turn depends on the nature of the increased gov spending
70
the _______ is the increase in potential output caused by a fiscal expansion, the _______ private expenditure will be crowded out
LARGER
LESS
71
long term burden of government debt
the cost to future generations caused by rises in gov deficit
caused by fact that the PRIVATE EXPENDITURE that was crowded out would have added more to the economy's productive capacity than what's added by the gov's expenditure financed by the budget deficit
72
whether the budget deficit harms future generations depends on the nature of...
nature of the GOODS and SERVICES being financed by the deficit
ie. could finance a project that generates a SUBSTANTIAL RETURN to future gens
ie. medical research, electric-powered transit network
but gov could also finance a project that mainly benefits the CURRENT GENN
ie. temporary cultural or sporting events
ie. tax reductions
73
gov budget deficits rep _______ that future gens must _____. whether these future gens are harmed depends on...
TAXES
PAY
whether these future gens are harmed depends on the NATURE OF GOV SPENDING FINANCED BY THE DEFICIT
74
capital budgeting
gov would essentially classify each expenditure item as either CONSUMPTION or INVESTMENT
consumption: spending that mostly benefits current gen
investment: spending that mostly benefits future gen
75
capital budgeting allows for what?
for undesirable redistributions of income between generations to be minimized
while still permitting some budget deficits
ie. gov may commit to borrowing no more in a given year than the expenditures classed as investments
76
do high levels of gov debt make conduct of _____ and _____ _____ more difficult?
monetary and fiscal policy
77
how does a large stock of gov debt hamper conduct of monetary policy?
consider country with high debt-to-GDP ratio and real interest rate above the growth rate of GDP
here, debt-to-GDP ratio will CONTINUE TO GROW unless gov starts running SIGNIFICANT PRIMARY BUDGET SURPLUSES
this requires 1) increasing taxes or 2) reducing program spending
if these seem unachievable, foreign and domestic bondholders will expect gov to put pressure on central bank to purchase (MONETIZE) an increasing portion of its deficit
such monetization means the money supply will increase, and EVENTUALLY CAUSE INFLATION
fears of future debt monetization = expectations of high inflation = upward pressure on longer-term nominal interest rates
so even in ABSENCE OF CURRENT ACTIONS by central bank to increase the money supply, LARGE GOV DEBT MAY LEAD TO EXPECTATION OF FUTURE INFLATION
this hampers the task of the central bank in keeping inflation low
78
how does a large stock of gov debt hamper conduct of fiscal policy?
recall: fiscal policy can stabilize AD and real GDP
counter-cyclical fiscal policy: fiscal expansions during recessions, or fiscal contractions during booms
recall equation:
change in d = x + (r - g) x d
change in d depends on CURRENT LEVEL of d
if r > g, the increase in d will be higher if d is already high
consider: recession and gov is considering expansionary fiscal policy
this could increase primary budget deficit (x)
on one hand, short term benefits from higher GDP
on other hand, gov is wary of increasing the d
with small d, gov has flexibility
but if d is high, less flexibility because d will be increasing very fast
any increase in x associated with counter-fiscal policy runs danger of generating increases in d
this is viewed by creditors as unsustainable - may lead to increase in real interest rate on gov debt (drives d up even more)
79
3 proposals - legislation to impose restrictions on budget deficit sizes
1. annually balanced budgets
2. cyclically balanced budgets
3. maintaining a prudent debt-to-GDP ratio
80
annually balanced budgets
this is extremely hard
ie. entire debt-servicing (i x D) component can't be altered by current gov
would also prob be UNDESIRABLE to balance the budget every year
ie. tax-and-transfer system as a stabilizing agent - in recessions, increase in budget deficit stimulates AD and in booms, budget surplus reduces AD but with balanced budget, gov expenditure would be FORCED TO ADJUST to changing level of tax revenues
^ generates MAJOR DESTABILIZING FORCE on real GDP
81
an annually balanced budget would eliminate what?
the automatic fiscal stabilizers (of the tax and transfer system)
this could ACCENTUATE swings in real GDP
82
cyclically balanced budgets
require govs balance their budgets over a FULL ECONOMIC CYCLE
deficits would be permitted in recessions as long as they were matched by surpluses during booms
1. would allow automatic stabilizers to play their important role
2. but also would prevent buildup of gov debt
but also has problems
83
biggest problem with cyclically balanced budhets
operational problem
requires DEFINING the economic cycle precisely
people disagree on this, and there are political stakes
84
balancing the budget over the course of the business cycle is in principle a desirable means of reconciling...
RECONCILING the short term STABILIZATION with long term FISCAL PRUDENCE
but the difficulty in presciley DEFINING the business cycle suggests that govs could best follow this as an APPROXIMATE GUIDE rather than formal rule
85
maintaining a prudent debt-to-GDP ratio
problem with policy requiring a balanced budget = emphasis is on the OVERALL BUDGET DEFICIT
but we know that what determines the change in the debt-to-GDP ratio is the GROWTH OF DEBT RELATIVE TO THE GROWTH OF THE ECONOMY
with growing economy, can have positive overall budget deficits (and growing debt) with a falling debt-to-GDP ratio
so the relevant focus should be the DEBT-TO-GDP RATIO - not the budget deficit itself
86
T/F: with growing economy, can have positive overall budget deficits (and growing debt) with a falling debt-to-GDP ratio
true
87
what does a low and relatively stable debt-to-GDP ratio entail?
a budget deficit such that the STOCK OF DEBT GROWS NO FASTER THAN GDP
88
the "maintaining a prudent dept-to-GDP ratio" approach recognizes that not all...
government debt presents a problem
89
why is the annual deficit equal to the annual increase in the stock of government debt?
because the government must BORROW to finance any shortfall in revenues
