Deficit relative to gdp rises during recessions and

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Deficit relative to GDP rises during recessions and wars and fall during expansionsDeficit as %age of GDP was actually much higher in 1993 than in 2003 even though the opposite is true when plotted in dollars. (size of economy matters)1983-1993 – Bud/GDP ratio was in deficit even though economy was expanding and in peace Budget agreement of 1993surplusoDebt/GDP ratio is difficutl to reduce, high during WWIIdecline, required GDP to grow faster than debt (deficits were small compared to GDP)
Debt/GDP ratio has risen during the financial crisisCompared w/ other countries, ND/GDP is moderate in US but still a problem that needs to be dealt with. Bud=Gbar+TRbar+InP-TXbar-tYoGovt does not control interest payments on debt OR income – budget can change even w/out fiscal policy change (but important to note whether change in deficit is due to change in FP or other factors)Analysis: Suppose Bud=0 and Govt does not change Fiscal Policy Instruments (G, TR t, TX)Suppose Y falls due to a RecessionY downtY downBud>0Why? Govt does not control tax revenues (tY)Taxes falling in a recession is an automatic stabilizer, prevents disposable income and consumption from falling as much as it otherwise would. Economic AnalysisoBalanced Budget Proposal: should the govt. balance the budget every year?Advocates: Restrains govt. spendingNo debt burden on future generationsOpponents: Govt. should be able to borrow to balance purchases of long-lived assetsoInvestments in public capital – infrastructure (roads, ports, airports, etc)oMilitary hardwarePotentially de-stabilizingoSuppose the economy is in equilibrium, so Bud=0. Suppose Ibargoes downrecessionP&Y go down. If Gbar,TRbar,, TXbar, and t are kept constant then TX=TXbar+tY declines because Y has fallenBud>0oIf govt attempts to balance the budget, it would have to lower Gbar,TRbarand raise TXbarand tbar. This would SHIFT AD FURTHER LEFTworsen recessionConsensus: Deficits should be permitted to occur in recessions and during Wars.Main problem: persistently high Deficit/GDP ratios in an expanding economy and during peacetime. oDebt Finance – govt sells bonds to (i.e. borrows from) the private sector to finance deficits
Burdens: interest on debt is paid by future generations (CLAIM: will have to sacrifice consumption and standard of living to pay interest on debt)False if debt is held by US citizens (they will be beneficiaries of interest on debt), true if debt is held by foreigners57% of govt. debt is now held by foreigners-claim is TRUECrowding out of private investment (CLAIM: leaves future generations with smaller capital stocksmaller productive potentiallower standard of living) HOW?Assume: completely slack conditions, Bud=0, closed economy.

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