The Government and Macroeconomy

Question 1

What is the Budget Balance? How can a Governemnt finance this?

Answer 1

• Budget Balance is the difference between T&G, illustrating how spending occurs
• T>G surplus, T<G deficit
• To finance this, a Government can print money or borrow money via selling bonds
• In 2023, the UK issued £240bn in bonds

Question 2

Do Governments need to balance the budget?

Answer 2

• They do not always need a balanced budget at every period
• But it is required that there is a balance in the present discount value
• Public Debt = Sum of all deficit = PDV of future surplus
• Sustainability depends on taxes and expenditure in the future

Question 3

What are the biggest inflows and spendings for the UK Government?

Answer 3

• SPENDING: Social Protection, Education, Health
• INFLOWS: Income Tax, NICs, VAT, Corporation Tax

Question 4

What is the difference between a Government deficit and Government debt?

Answer 4

• Deficit is a flow variable: I.E. is the the change in Government Debt
• Debt is a stock variable: This value is the total outstanding bonds that are issues; measured by Debt:GDP

Question 5

How is the UK spending patterns compared to the OECD average? How can other countries have a negative GDP?

Answer 5

• UK has lower than average spending compared to OECD nations
• Norway: Negative Debt to GDP due to natural reserves
• Germany: Negative Debt to GDP due to “debt brake” -> 0.35%

Question 6

What is the Government Budget constraint?

Answer 6

• Total deficit = Taxes + Change in Borrowing and Change in MS
• OR: Gt + Trt + iBt = Tt + ΔBt+1 + ΔMt+1
• Primary deficit = Gt + Trt - Tt
• It is often assumed that Trt and ΔMt+1 are 0; therefore:
  Bt+1 = (1+i)Bt + Gt - Tt

Question 7

How can the intertemporal budget constraint be met?

Answer 7

• Assume 2 periods, penultimate and last (P2 and P3)
• In P2, Budget constraint is; B2 = (1+i)B1 + G1 - T1
• In P3, Budget constraint is; B3 = (1+i)B2 + G2 - T2
• Combining this, we see:
  B3 = (1+i) [(1+i)B1 + G1 - T1] + G2 - T2
• If loans can never be repaid, B3 = 0 due to 0 lending
• Dividing by (1+i) and rearraging, it is:
  G1 + G2/(1+i) + (1+i)B1 = T1 + T2/(1+i)
• This illustrates that the Government must pay off debt in one of the periods

Question 8

What are some implications of high borrowing (DEBT:GDP)?

Answer 8

• If Nominal GDP grows faster than debt, debt:GDP falls
• Growth in nominal GDP is accounted by π and g
• Growth in debt depends on the nominal interest rate
• Nominal Stock evolves: B turns to B(1+i) turns to B(1+i)^2; causing NGDP to grow, illustrated below:
  PY turns to (1+π)P(1+g)Y turns to (1+π)^2P(1+g)Y^2
• Dividing B/Y, we get:
  B/Y = [(1+i) / (1+g)(1+π)][B/PY] + [(1+i)^2 / (1+g)^2(1+π)^2][B/PY] + ….

Question 9

What are some implications of high borrowing (INFLATION+DEFAULTS)? What issues do these cause?

Answer 9

• If Debt:GDP ratio becomes too high, investors will doubt ability to repay debts, thus demand a higher i
• If lenders stop (ΔBt+1 = 0), the Government may print more money, increasing π and M or they default
• Sovreign Default occurs when a Government says that it cannot repay debt. This leads to huge issues of:
  INTERGENERATIONAL EQUITY
  DEFICIT ‘CROWDING OUT’ INVESTMENT

Question 10

What is Intergenerational equity?

Answer 10

• Auerbach and Kotlikoff developed generational accounting, measuring fiscal burden of generations
• High or Rising Debt:GDP implies higher taxes for future generations
• When Government borrows, we can see that the beneficiaries aren’t the repayers
• For example, WWII did not directly benefit 1960s, but they had to repay this

Question 11

What is Deficit and Investment via crowding out? How does this link to borrowing?

Answer 11

• Investment is financed by savings: Domestic, Foreign or Government
• Crowding Out: Budget deficit absorbs private/foreign savings
• Y and NM increase due to Government demand for goods increasing
• C decreases responding to greater demand for funds by the Government
• Ricardian Equivolance implies that the timing of taxation does not affect consumption (PIH)
• THUS, NO CROWDING OUT

Question 12

What are some growing fiscal expenditures?

Answer 12

• Ageing Population: Healthcare spending and pensions increase
• Climate Emergency: Increase in Green Investments due to investment
• Fairness: Redistributive measures create distortions
• SUSTAINABILITY: G will rise, OBR estimate 274% National Debt by 2071, but only 40% revenue

Question 13

Provide the Case Study on Public Health Spending

Answer 13

• Health related public spending will reach around 13%
• Better treatment increases health expenditure
• INCOME EFFECT: increased consumption and lower marginal utility usually occur, not the case for life
• NHS is financed via central taxes and NICs
• Pay-As-You-Go; current spending funded via taxes
• However, taxes are falling, due to a smaller work force
• SOLUTIONS: Tax revenues, Economic Growth, Technological Advancements