Topic12-Fiscal Policy_AAPBW6_Rev

Purchases gov ss payments welfare payments interest

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Unformatted text preview: and the Debt-GDP ratio to climb Debt- • What are the budget deficit and the primary deficit? Def = Def(Prim) = Def(Prim) Does it matter? 28 28 35 Example #1 gov. purchases gov. SS payments Welfare payments Interest on Debt Income taxes Corp taxes SS & Medicare levies Debt (cnt.) cnt.) = 300 = 200 = 100 = 30 = 220 = 40 = 140 • Dynamics of debt Dt+1 – Dt = Deft Def Dt+1 – Dt = Primary Deficitt + it-1 Dt Primary where it = nominal interest rate Deficits add to the government’s debt government’ • What are the government transfers? TR = TR • The Debt/GDP ratio is a reasonable measure Debt of the impact of debt 31 36 How Indebted Are the World’s Governments? Actual & Projected Deficits Country Debt to GDP ratio in 1998 Belgium 125% Italy -0 8 -0 6 ar 65 65 65 United Kingdom M -0 4 ar ar M M -0 0 -0 2 -9 8 ar ar M ar M M -9 4 -9 6 -9 2 ar ar M M -9 0 ar M ar M M ar -8 8 -8 6 -8 4 ar ar M -8 0 -8 2 M ar ar M -7 6 ar -7 4 ar ar -7 8 M M M -7 0 -7 2 66 United States 34 67 France -10.0% 67 Portugal FED DEFICIT CBO PROJECTED 73 Germany M ar ar M M -8.0% 73 Denmark -6.0% 74 Netherlands Ireland -4.0% 76 Spain Austria -2.0% 93 Sweden 0.0% 94 Japan 2.0% 103 Canada 4.0% 123 Greece Actual and Projected Federal Deficits 60 Source: Mankiw 2000 37 The Debate on Budget Deficits The Traditional View (cnt.) cnt.) • Government levies taxes to finance its spending • According to the traditional view, the reduction in the future standard of living is the true burden of government debt • The argument crucially depends on how consumers behave in response to such a tax cut (through Spvt) • “If some of the debt is held by foreigners, then the future generations will also have to pay interest to them.” them.” It can levy taxes equal to G1 T1 = G1 It can tax T1 < G1 (current scenario) and borrow borrow (G1 - T1) to finance spending; i.e. run a deficit and sell debt • Is this “good” or “bad” for the economy? good” bad” Current generations? Future generations? This is true but irrelevant, as long as the debt is in home currency 39 39 The Traditional View of Deficits 42 The Traditional View (cnt.) cnt.) Traditional view: • A tax cut of $1 • Notice that the issue is NOT: how will our NOT children pay all this back? disposable income by $1 What it is about paying back the debt? Is it optimal to ever do that? ever part is consumed and the rest saved Spvt by < $1, while deficit Sgov by $1 As a result, Spriv + Sgov (total saving), S, Equilibrium real interest rate Investment 40 43 Example #2 (Traditional View) The Traditional View (cnt.) cnt.) • With persistent deficits, accumulation of domestic capital slows down future generations will experience a lower standard of living Solow model predicts a lower steady state level of capital and per capita income when the saving rate decreases 41 • Suppose private consumption is given by C = C0 + (Y – T) ; = 0.60 (Keynesian consumption function) C0 = 100, Y = 2,000, T = 600, G = 600 600, 600 What is Curr...
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This note was uploaded on 03/02/2010 for the course BUAD 350 taught by Professor Safarzadeh during the Spring '07 term at USC.

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