Lecture 7 - Government and Macroeconomy

Question 1

What is the government budget constraint?

Answer 1

Gₜ + Trₜ + iBₜ = Tₜ + ΔBₜ₊₁ + ΔMₜ₊₁
Where:
• G = Government purchases
• Tr = Transfer payments
• iB = Interest on debt
• T = Tax revenues
• ΔB = New borrowing
• ΔM = Money printing

Question 2

What are the 3 possible budget states?

Answer 2

1. Surplus: T > (G + Tr)
2. Deficit: T < (G + Tr)
3. Balanced: T = (G + Tr)

Question 3

How can governments finance deficits?

Answer 3

1. Borrowing (ΔB)
2. Printing money (ΔM)

Question 4

What is the intertemporal budget constraint?

Answer 4

PDV of spending + initial debt = PDV of taxes
Formula:
(1+i)B₁ + G₁ + G₂/(1+i) = T₁ + T₂/(1+i)
Key: Must balance in present value across periods

Question 5

What determines debt sustainability?

Answer 5

• Future tax revenues
• Future spending
• Economic growth rate (g) vs interest rate (i)

Question 6

When does the debt-GDP ratio decline?

Answer 6

When: i < g + π
(i = nominal interest rate, g = real GDP growth, π = inflation)

Question 7

What is crowding out?

Answer 7

When government borrowing reduces private investment by increasing interest rates

Question 8

What is Ricardian equivalence?

Answer 8

Theory that deficit spending doesn’t affect consumption because households anticipate future taxes to pay debt

Question 9

Why is Norway’s debt negative?

Answer 9

Due to:
1. Government-owned petroleum reserves
2. Savings in sovereign wealth fund (not choice c)

Question 10

What are key 21st century fiscal challenges?

Answer 10

1. Aging populations (↑ healthcare/pensions)
2. Climate change investments
3. Rising inequality

Question 11

What was UK’s 2023-24 budget deficit?

Answer 11

4.8% of GDP (£1,189bn total spending)

Question 12

What % of UK revenue comes from income tax?

Answer 12

25% (largest single source)

Question 13

What happens if debt becomes unsustainable?

Answer 13

1. Higher interest rates demanded
2. Risk of default
3. Potential inflation from money printing

Question 14

What is generational accounting?

Answer 14

Auerbach/Kotlikoff framework measuring fiscal burdens across generations

Question 15

Why is healthcare spending rising?

Answer 15

1. Aging population
2. Expensive medical tech
3. High value of life extension

Question 16

What are solutions to rising healthcare costs?

Answer 16

1. ↑ Taxes by ~5% GDP
2. Productivity improvements
3. Economic growth

Question 17

What was US 2023 budget deficit?

Answer 17

5.9% of GDP ($4,700 per person)

Question 18

What % of US spending goes to Social Security?

Answer 18

5.1% of GDP (2nd largest after Health)

Question 19

What is primary deficit?

Answer 19

G + Tr - T (excludes interest payments)

Question 20

What triggers sovereign default?

Answer 20

1. Debt-GDP ratio too high
2. Loss of lender confidence
3. Inability to roll over debt