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Flashcards in Long run fiscal policy Deck (122):
1

is government spending in oecd countries greater now or 100 years ago

government spending is many times greater than 100 years ago

2

what are the two different elements of public spending

expenditure on consumption (civil servants' salaries),
investment goods (eg new hospital)

3

how is government expenditure on consumption and investment shown on equation Y=C+G+I+NX

consumption through G,
investment through I

4

how are transfer payments by the government shown on the equation Y=C+G+I+NX

they affect C via their impact on household disposable income

5

what are the three ways a government can distribute income

over an individuals lifetime (tax when young benefits when old),
across households (high taxes high income),
across generations (intro of state pension)

6

what is Dt

real debt at end of t

7

what is Tt+1

taxation (in real terms at end of period)

8

what is Govt+1

government spending

9

what is rt+1Dt

interest on outstanding public debt

10

what is a primary budget deficit

when govt+1 > Tt+1

11

how does a ponzi scheme work

attract new investors by offering unusually high returns,
pay current investors using the money from the new investors rather than from profits earned

12

what does no ponzi schemes mean

can't pay off debt with evermore amounts of debt

13

what's d

debt to gdp ratio d=D/Y

14

what is pst+1

primary surplus-to-gdp ratio in period t+1

15

what is gt+1

economy's growth rate between t and t+1

16

what is r equal to (fisher equation)

r = i - π

17

does debt to gdp stay similar over time

nom the debt-to-gdp ratio can change dramatically over time

18

all else being the same what happens when aggregate (public and private) capital does not grow as fast as it would have done under a lower public debt burden *

the economy's productive capacity will also be permanently lower due to the crowding-out effect of public debt on private investment

19

what are the two main components of government spending

public spending and transfer payments

20

what can public government spending be split into

expenditure on consumption goods (civil servants' salaries) and expenditure on investment goods (new hospital)

21

examples of transfer payments by the government

state pension for retired,
jobseekers allowance for the unemployed,
maternity pay for mothers with young babies

22

without investment what can't happen

an economy's productive potential can't grow

23

what are the two basic ways of financing a given amount of real government spending

through taxation or debt accumulation

24

are fiscal policy decisions over time related to each other

through the GIBC fiscal policy decisions over time are interdependent of each other (lower taxes today must imply greater taxes at some point in the future)

25

does the GIBC preclude an increase in real debt over time

no, as long as that debt grows on average below he average real rate of interest paid on the debt, condition (a) will be verified

26

does the government have to repay the debt at some point

it is perfectly possible for the government to verify the GIBC without ever fully repaying the national debt

27

what is paying interest on the debt forever equivalent too

paying interest on the debt forever is equivalent, in present value terms, to paying the debt immediately

28

what does pst+1 represent

primary surplus-to-gdp ratio

29

what does gtildat+1 represent

economy's growth rate between t and t+1

30

what happens when the real interest rate paid on the debt is greater than the economy's growth rate

stabilising the debt to gdp ratio requires a country to run, on average a primary budget surplus

31

the _____ the initial debt-to-gdp ratio and the _____ the difference between the real rate of interest paid on debt and the economy's growth rate the larger the primary surplus-to-gdp ratio must be

greater, greater

32

how did the financial crisis affect governments in terms of interest rates *

financial markets lost confidence in countries' abilities to keep debt under control so required higher rates on government bonds than before, this put enormous pressure on governments to generate primary budget surpluses

33

what does At stand for

index of technical progress

34

how does the variable At (index of technical progress) grow

grows exogenously at rate g per period

35

what rate does the labour force Lt grow at each period

n

36

what happens to K every period

depreciates at rate δ

37

equation for output and capital per effective worker *

yt = Yt / AtLt,
kt = Kt / AtLt

38

in equilibrium under perfect competition what do firms equalise

firms want to equalise their marginal product of capital (MPKt) and their marginal product of labour (MPLt) to their respective rental rates rt + δ and wt

39

in equilibrium under perfect competition what is the marginal product of capital equal to (MPKt) *

MPKt = rt + δ

40

in equilibrium under perfect competition what is the marginal product of labour equal to (MPLt) *

wt

41

what is alpha in the cobb douglas equations

it is the share of physical capital

42

in general equilibrium what is a higher kt associated with

a higher kt must be associated with a lower rt,
due to αkt^α-1 = rt + δ

43

what are the two equilibrium equations for equilibrium in perfect competition (firm in equilibrium) (write out)

αkt^α-1 = rt + δ

(1-α)Atkt^α = wt

44

what does g 'tilde' represent

per period growth rate of effective workers, AL

45

what is β

subjective discount factor, captures impatience

46

in the steady state what happens to capital per effective worker

it must be constant

47

draw the graph of the evolution of the capital per effective worker over time *

page 25 of book,
write out and understand

48

for graph of capital per effective worker over time what happens to it as g decreases

the curve shifts up,
this is because gtilde = (1+g)(1+n) so as g increases the bottom of the equation gets smaller so it increases 26

49

for graph of capital per effective worker over time what happens to it as n decreases

the curve shifts up,
this is because if there is a smaller population then there will be more capital per effective worker cause there is less workers

50

for graph of capital per effective worker over time what happens to it as beta decreases

curve shifts down,
this is because individuals are more impatient so save less money in period 1 so less is used for investment so will accumulate less capital

51

what does α capture

the extent of diminishing returns to capital

52

equation for gross savings rate st *

st = St / Yt

53

equation for gross national saving *

St = Kt+1 - Kt + δKt or simply St = Kt+1 - (1-δ)Kt,
writing out might help

54

Yt can be written Yt=Kt^α(AtLt)^1-α but how can it also be written *

Yt = AtLtkt^α,
small k

55

what is the saving rate in the OLG model when the economy is outside the steady state

the saving rate in the OLG model is non-constant when the economy is outside the steady state

56

once kt has converged to k* what happens to the economy's saving rate

once kt has converged to k*, the economy's saving rate will be constant

57

what is decentralised competitive equilibrium

the result of the interaction of many small agents that act as price takers in all markets

58

what is the golden rule of capital accumulation

requires that the real interest rate is equal to the economy's growth rate,
rGR = gtilda

59

what is wrong with the decentralised competitive equilibrium

each generation maximises its well-being without taking into account the impact of capital accumulation on future generations

60

is the competitive equilibrium pareto efficient

yes, there is no allocation of the economy's resources which would increase the utility of at least one generation without reducing the utility of some other generation

61

what can financing government expenditures do

the financing of government expenditures can significantly crowd out capital accumulation

62

what do greater expenditures by the government do

greater expenditures by the government will typically directly increase households' utility

63

what does taxation do to individuals

alter incentives to save and incentives to work

64

in terms of the per-period budget constraints what does θ mean

θ is the labour tax rate

65

in terms of the per-period budget constraints what does λ mean

λ is the capital income tax rate

66

what does a higher λ (capital income tax rate) do to consumption in terms of substitution effect

since price of future consumption rises with λ, a higher λ should make people want to substitute future consumption for more present consumption and more leisure

67

what is the income effect of a higher λ (capital income tax rate)

lowers reward for saving so produces a negative income effect, people respond to this by reducing consumption in both periods and also reducing leisure

68

what is the overall effect of an increase in λ (capital income tax rate) *

leads to a decrease in c2,t+1 (income and substitution reinforce each other) but what happens to consumption and leisure cannot be determined (since two effects point in opposite directions)

69

what does a higher θ (labour tax rate) do to leisure and work

a higher θ decreases the price of leisure so encourages more leisure but because the person is a net supplier of leisure this creates a negative income effect so it cannot be determined

70

what does an increase in θ (labour tax rate) do to consumption

reduces consumption in both periods

71

what does σ capture

captures the extent to which the young household values leisure relative to consumption

72

what does the extent of crowding out depend on

the extent of crowding out depends on the type of taxes being used and on the difference between the economy's real rate of interest r and the economy's growth rate gtilda

73

what is crowding out *

when higher government spending crowds out capital accumulation because higher government spending causes an equivalent fall in private sector spending and investment

74

why does crowding out happen *

because the higher government spending is funded by increasing taxing or increasing borrowing

75

why does increasing taxes cause crowding out *

if there is higher taxes then firms and consumers will have lower incomes so will lower investment and consumer spending

76

why does increasing borrowing cause crowding out *

when government borrows it borrows from private sector by selling bonds, when the private sector buys these bonds then they don't use the money for private sector investment so it crowds out investment

77

does the governments choice of spending affect household's utility and spending decisions

does affect household's utility but does not affect their marginal decisions since c1,t and c2,t+1 are independent of govt and govt+1

78

what does more labour income taxation do

reduces disposable income of the young, who respond by reducing consumption as well as their savings, lower aggregate savings then translates into lower aggregate investment in capital

79

there is ____ crowding out as government spending increases

more

80

is more crowding out due to more government spending a bad thing

does not mean that people are necessarily worse off, depends on how useful those government expenditures are in terms of lifetime utility

81

what does capital income taxation not do

capital income taxation does not crowd out capital and so leads to higher gross labour income

82

what is debt essentially

deferred taxation

83

what does debt accumulation have a substantial impact on

debt accumulation has a substantial redistributional impact across generations,

84

how does debt accumulation affect the generation accumulating the debt and future generations

the generation that enjoys government expenditures without paying for them benefits at the detriment of all other generations

85

what is debt policy

government borrowing amount d from each worker and paying back (1+r*)d one period later

86

what is the effect of debt policy on the individual

impact on the individual's lifetime wealth is zero since in present value terms -d+((1+r*)d)/(1+r*)=0

87

what is assets policy

lending amount -d to each worker and then receiving principal and interest in the following period

88

what is the effect of assets policy on the individual

impact on the individual's lifetime wealth is zero

89

what does ce stand for

competitive equilibrium

90

what does gr stand for

golden rule

91

what is the unfunded pay-as-you-go pension system

the working generation pays for the pensions of the retired generation

92

what is the fully funded defined contribution system

the pension that a retired person receives depends on their contributions to the system (made while working) as well as on the cumulative rate of return obtained from those financial investments

93

what is the adverse effect of greater generosity from the PAYG pension system

the greater its generosity, the greater its crowding out effect on capital accumulation

94

which system is better if there were no problems of myopia, lack of information etc the PAYG system or defined contribution system

a fully funded defined contribution system would always be superior to a PAYG system

95

what would the introduction of a PAYG system do

the introduction of a PAYG system would benefit the old generation at the expense of all the other ones

96

what are the relative r and g levels when an economy is on a balanced growth path and has capital intensity below the golden rule level

real rate of interest is greater than the economy's growth rate (r>gtilda)

97

what does τ represent

payroll tax rate (how much taxes the working pay in a PAYG system)

98

in a balanced and sustainable PAYG system what is the rate of return on the average worker's contribution to the system

rate of return is equal to the rate of growth of the economy

99

how does the rate of population growth and the rate of GDP per capita growth affect the rate of return

the lower the rate of population growth (n) and the lower the rate of GDP per capita growth (g) the lower the rate of return

100

the ____ the rate of population growth (n) and the _____ the rate of GDP per capita growth (g) the lower the rate of return

lower, lower

101

what happens with a greater τ (payroll tax rate)

the greater τb the larger the crowding out effect

102

what are the two pension systems that there can be

PAYG system,
fully funded defined contribution system

103

in a fully funded system what is the rate of return on the average worker's contribution given by

r, the net return on capital

104

what does a fully funded pension system imply about the effective average tax rate on labour

implies an effective average tax rate on labour equal to zero

105

how is the equilibrium with a fully funded pension system the same as the baseline case

household recognises that the government is simply doing some of the saving for them by levying taxes, so keep consumption constant and allow private saving to decrease by the full amount of the taxes

106

who gains when a PAYG system is introduced

the generation born at time -1 since they receive a windfall of τbL0w0

107

why is it sometimes not best to have a contribution system

many believe voluntary arrangements will never be enough due to imperfections in financial markets and lack of perfect consumer information

108

which has higher administrative costs the funded system or the PAYG system

the administrative costs of a funded system are substantially greater than those of a state run PAYG system

109

what are the two main components of government spending

public spending and transfer payments

110

what is the rental rate of capital (K)

rt + δ

111

what is the rental rate of labour (L)

wt

112

how come g tilde is the per period growth rate of effective workers, AL

(1+gtilde) = (1+g) (1+n)

113

what is the key transition equation of the basic 2-period OLG model

kt+1 = φOLG(kt) = (1-α / (1+gtilde)(1+1/β)) kt^α,
24

114

what is k*OLG, steady state value k*

K*OLG = (1-α / (1+gtilde)(1+1/β)) ^ 1/1-α,
25

115

what is the extent of diminishing returns to capital captured by

α

116

what is gross national saving equal too

gross national investment

117

what happens if rce

there is excessive capital accumulation and the competitive equilibrium is said to be dynamically inefficient: a reduction in rate of saving of the young would benefit all generations (28)

118

what happens if rce>rgr (competitive equilibrium < golden rule)

even though an increase in capital and hence savings would eventually leave all future generations better off, some generations would lose out, the competitive equilibrium is Pareto efficient (28)

119

what is the substitution effect

change in consumption patterns due to a change in the relative prices of goods

120

what is the income effect

change in consumption patterns due to the change in purchasing power

121

what is difference between income and substitution effect

substitution effect due to change in relative prices of goods,
income due to change in purchasing power

122

what does the golden rule of capital accumulation state *

rGR = gtilda,
real interest rate (net return on capital) = economy's growth rate