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Unformatted text preview: Disclaimer: These notes were prepared based on lectures of Prof Sala-i-Martin’s 2008 Fall Course of Intermediate Macro-W3213. Contents of these notes might not match completely with the current teachings in class. 9.1 Government Spending So long we were dealing with closed economy without a government. Now we introduce the government sector. Like other economic agents govt. also needs to spend. How do we have change the model when we introduce Spending? First, it changes our view of demand since now, some of the output will be demanded (purchased) by the government. Aggregate demand now has three components Consumption (C), Investment (I) and govt. consumption expenditure (G). Y d = C+I+G 9.1 Second Spending can be Productive or Utility enhancing spending, and Useless spending. If spending were productive or affected the utility function then we would have to change the production function (Y s t =A t F(L t ,K t-1, G t )) or the utility function (U(c t ,G t )), both of which would now include G. To start, we will assume that public spending is USELESS so it does not affect the supply of output (or the productivity of private investments) or the utility function. Hence, we do not need to amend the production function or the utility function. Third, public spending needs to be financed (possibly with taxes) and this may have indirect effects on the desired (and available) levels of consumption and labor supply. To see this, we need to analyze the utility function of the government and then the BC of households. The Government Budget Constraint : The Budget constraint of the government equates total resources of the government (RHS) to total expenditure (LHS). The government has three sources of financing its spending: taxes, printing money and issuing debt. The expenditures include government consumption expenditure (G), government transfers and interest on outstanding debt. The Government Budget Constraintis given below: ? ? + ? ? + ¡ ¢ ?− 1 = ? + + ¢ ? – ¢ ?− 1 £ 9.2 G= real spending v= real transfers b g t = public debt outstanding at time t r b g t-1 = interest payments on outstanding debt T t = tax collection Δm s increase in nominal money supply Δm s /p real resources available through the increase in nominal money supply (b g t- b g t-1 ) =Δ b g t is the budget deficit. It gives the increase in government’s debt or the amount of bonds issued. Hence, the BC says that all the recourses spent by the government at time t (which include transfers as well as financial payments) is either paid or it is not paid. If it is paid, then the resources must come from either taxes or from the printing of money. If it is not paid, then it is owed (deficit)....
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This note was uploaded on 11/10/2011 for the course ECON 3100 taught by Professor Sala-i-martin during the Spring '11 term at Columbia.
- Spring '11