November 21 notes

November 21 notes - Burdens of Debt Finance Debt Finance:...

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Burdens of Debt Finance Debt Finance : Government sells Bonds to (i.e., Borrows from) the Private Sector to Finance Deficits •P o t e n t i a l B u r d e n s ± Interest on the Debt is paid by Future Generations ± Crowding out of Private Investment
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Debt Paid by Future Generations (i.e., Our Children) Claim : Our Children will have to sacrifice their Consumption and Standard of Living to pay the interest on the Debt •C l a i m h i n g e s o n w h e t h e r D e b t i s h e l d b y U S Citizens or Foreigners ¾ False if Debt is held by US Citizens ¾ True if Debt is held by Foreigners ¾ Approximately 47% of Government Debt is now held by Foreigners
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“Crowding Out” of Private Investment Claim : Debt Finance “Crowds Out” Private Investment •L e a v e s F u t u r e G e n e r a t i o n s w i t h S m a l l e r Capital Stock and thus Smaller Productive Potential o w e r s F u t u r e S t a n d a r d s o f L i v i n g •H o w ?
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Analysis: “Crowding Out” of Private Investment •A s s u m e : ¾ “Completely Slack” Conditions ¾ Begin with a Balanced Budget ¾ Closed Economy 0 Bud
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Model -( 1 - ) Fiscal Instruments: , , , YE ECIG CC b T Xb T R b t Y II i GG GTRTXt D ± ± ± ± ²
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Aggregate Planned Expenditure N Effective Intercept Slope -( 1 - ) 1 - ) ECIG Cb T X b T R b t Y I i G T X b T R I i G b t Y D ± ± ± ± ± ² ± ± ± ² ± ± ±²²²²³²²²²´
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Principle: 1 st Stage 1st Stage: (1) G Bud Bud > 0 ND (2) G E Y Debt Financed Increase in Government Purchases ±n ² n ² ² n n ² n
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Diagram: 1 st Stage
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2 nd Stage N Interest Capital Gain Return Interest Rate or Yield to Maturity on a Gov Bond 1 To sell Bonds, Gov Sets off Chain Reaction: GB MG B M GB GB GB GB GB GB GB GB i PP P InP InP i PPP P Pi ii iI ± ² ³ ³ ² ±p ´ n ±n ´ n ±n´ p ±²³ ²´ .
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November 21 notes - Burdens of Debt Finance Debt Finance:...

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