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Topic12-Fiscal Policy_AAPBW6_Rev

# 60 c0 100 y 2000 t 400 g 600 400 600 what is

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Unformatted text preview: ent Consumption, Priv. Saving, Current Priv. Nat’l Savings? Nat’ C SPriv SNatl 44 Example #2 (Traditional View) The Ricardian View of Deficits • Gov. decreases taxes to 400 without decreasing spending C = C0 + (Y – T) ; = 0.60 C0 = 100, Y = 2,000, T = 400, G = 600 400, 600 What is Consumption, Priv. Sav, Nat’l Sav? ’ Consumption Priv. Nat C = SPriv = SNatl = The Ricardian conclusion is that consumers will save all such tax cuts, and national savings will save national not change Private savings will offset the government deficit We’ll show this in a simple model We’ • Assume government cuts taxes and runs a deficit, while holding current and future while government expenditures fixed Taxes are lump-sum lump- 48 48 Brief Review 54 The Ricardian View of Deficits • Deficit = (G + TR + INT) - T TR INT Debt/GDP is the usual way we compare deficits over time and across countries • What is the traditional “burden of the debt”? debt” Lower std of living; not the interest payments not • The “thought experiment” is: experiment” Gov cuts taxes while holding spending the same Bush policy (also the old Reagan policy) Does this change private behavior? “Traditional View” YES! Reduces Nat’l View” Nat’ Savings, k, and therefore steady state y • The budget constraint for a consumer in the 2-period model is (discussed in T.6) PV(consumption) = PV(net income) (consumption) PV C1 C2 Y T Y1 2 T1 2 1 r 1 r 1 r Recall that the PV of a series of cash receipts over PV time is: PV X 0 , X 1 , X 2 , X 3 X 0 X1 X2 X3 1 r 1 r 2 1 r 3 51 The Ricardian View of Deficits 55 Ricardian View (cnt.) cnt.) • Ricardian view: postulates a forwardforwardlooking consumer and examines if a tax cut will consumption Simple logic of government’s budget constraint: government’ PV(Gov Spending) = PV(Tax Revenue) Otherwise no one would lend to government Current deficits (& therefore lower taxes) lower imply future higher taxes higher Conclusion: the “tax cut” is not a tax cut in PV cut” in 53 • The government’s government’ constraint, is: intertemporal budget PV (Gov. Expenditures) = PV (Taxes) PV PV G G1 G2 T T1 2 PV T 1 r 1 R 56 Ricardian View (cnt.) cnt.) Ricardian View (cnt.) cnt.) • If planned government expenditures do not change (Fix G1 and G2 ) change • In algebraic terms Government decreases taxes by T today and finances this tax cut by borrowing, In the next period it needs to increase taxes by (1+r) (1+ T, to repay the debt and the accumulated interest PV G T1 T T2 T 1 r PV T 1 r Consumer’s budget constraint with this tax cut: Consumer’ Y2 T 1 r T T1 T 2 1 r 1 r Y2 G 2 Y1 G1 1 r PV Y1 57 57 Ricardian View (cnt.) cnt.) 60 Ricardian View (cnt.) cnt.) • What happens to the consumer’s budget constraint? consumer’ She gets a tax break of T, so her first period income is T She knows that the government has to go out and borrow T to finance its expenses She also foresees that the government will have to repay its debt debt and it will have to increas...
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