325_Lecture9_Feb21

325_Lecture9_Feb21 - GOVERNMENT AND FISCAL POLICY IN THE...

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1 G OVERNMENT AND F ISCAL P OLICY IN THE C ONSUMPTION- S AVINGS M ODEL (CONTINUED) F EBRUARY 21, 2011 February 21, 2011 2 AD YNAMIC M ODEL OF THE G OVERNMENT A Government in the Two-Period Model ± So far only consumers in our two-period framework ± Introduce government in very simple form ± Exists for both periods ± Has spending in each period it needs to finance – can be financed via ± Taxes ± Issuing government debt/assets ± Notation ± g 1 :r e a l g o v e r n m e n t s p e n d i n g i n p e r i o d 1 ± g 2 e a l g o v e r n m e n t s p e n d i n g i n p e r i o d 2 ± b 0 :g o v e r n m e n t a s s e t p o s i t i o n a t b e g i nning of period 1/end of period 0 ± b 1 o v e r n m e n t a s s e t p o s i t i o n a t b e g i nning of period 2/end of period 1 ± b 2 o v e r n m e n t a s s e t p o s i t i o n a t b e g i nning of period 3/end of period 2 ± r e a l i n t e r e s t r a t e b e t w e e n p e r i o d s
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2 February 21, 2011 3 G OVERNMENT B UDGET C ONSTRAINT(S) Model Structure ± Adopt a lifetime view of the budget constraint(s) ± All analysis conducted from perspective of beginning of period 1 ± Period-1 government budget constraint ± Period-2 government budget constraint ± Combine into lifetime budget constraint (LBC) ± Solve period-2 budget constraint for b 1 ± …and substitute into period-1 budget constraint 111 0 (1 ) g bt r b ± ±± 222 1 ) g r b Asset position at end of period 1/beginning of period 2 the key link Assume = 0 (fully-rational, informed, benevolent government) 22 11 0 ) gt g tr b rr ± ±± ± ± ± Present discounted value (PDV) of all lifetime government expenditure Present discounted value (PDV) of all lifetime government income For graphical simplicity, will often assume b 0 = 0 (i.e., government begins life with zero net wealth). Note this is a different assumption than b 2 = 0. IMPORTANT : Government must balance its budget over its lifetime , not necessarily in each period February 21, 2011 4 C ONSUMER B UDGET C ONSTRAINT(S) ± Introduce tax payments into consumer side of framework ± All in real terms for simplicity – can cast in nominal terms by multiplying by P ± Period-1 budget constraint ± Period-2 budget constraint ± Combine into lifetime budget constraint (LBC) ± Solve period-2 budget constraint for a 1 ± …and substitute into period-1 budget constraint 11 1 0 1 0 ctaa yr a ± ±² ± 22 2 1 2 1 ctaayr a ± 2 1 0 ) cy t t r a ² ² ± ± ± ± ± Present discounted value (PDV) of all lifetime expenditure Present discounted value (PDV) of all lifetime disposable income (i.e., after-tax income)
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3 February 21, 2011 5 E CONOMY- W IDE R ESOURCE F RONTIER Macro Fundamentals ± Consumer lifetime budget constraint ± Government lifetime budget constraint ± Summing the two yields economy-wide resource frontier ± aka “production possibilities frontier” (PPF) ± The GDP accounting equation in two-period form 22 2 11 1 0 (1 ) cy t t r a rr ± ² ± ² ² ² ² ² 0 ) gt g tr b ²² ² ² ² 2 1 0 0 )( ) g g r a b ± ± ² ² ² ² ² ² Suppose = 0 for graphical simplicity c 1 c 2 slope = -(1+ r ) y
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This document was uploaded on 11/01/2011 for the course ECON 325 at Maryland.

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325_Lecture9_Feb21 - GOVERNMENT AND FISCAL POLICY IN THE...

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