Order Government Debt and Deficits

Order Government Debt and Deficits
Order Government Debt and Deficits

Question 2
a) national income (real GDP) rises
b) falls; rises
c) potential GDP; taxing and spending policies
d) primary budget surplus
e) increase; \$8.5; rise; less than \$8.5
Question 4
a) Recall that the overall budget deficit is equal to total government expenditure, including
debt-service payments, minus total government net tax revenues. See the completed table
below.
b) The primary budget deficit is equal to the overall deficit minus the debt-service
payments. Or, equivalently, it is equal to non-debt-service expenditures minus government
net tax revenues. See the table below.
Year
Total Deficit
G iD – T
Primary Deficit
G – T
Stock of Debt
Dt = Dt-1 ∆Dt
1999 175 25 – 175 = 25 175 – 175 = 0 400 25 = 425
2000 180 26 – 180 = 26 180 – 180 = 0 425 26 = 451
2001 185 27 – 185 = 27 185 – 185 = 0 451 27 = 478
2002 188 26 – 190 = 24 188 – 190 = –2 478 24 = 502
2003 185 25 – 195 = 15 185 – 195 = –10 502 15 = 517
2004 185 24 – 200 = 9 185 – 200 = –15 517 9 = 526
2005 180 23 – 205 = –2 180 – 205 = –25 526 – 2 = 524
2006 175 22 – 210 = –13 175 – 210 = –35 524 – 13 = 511
c) The overall budget deficit in any given year is equal to the change in the stock of debt,
from that year to the next. Thus, the overall deficit of \$25 billion in 1999 adds to the initial
stock of debt of \$400 billion so that by the end of 1999, the new stock of debt is \$425
billion. This is shown in the first row.
d) The same method as used in (c) is used for the remaining years. The stock of debt rises
from 1999 to 2004 because the overall budget deficits in those years are positive. But
beginning in 2005, the budget surpluses (negative deficits) imply that the stock of debt
begins to fall.
e) The stock of debt grew from \$400 billion in 1998 to \$511 billion at the end of 2006, an
increase of 111/400 = 27.8 percent. If the debt-to-GDP ratio was unchanged over this
period, then GDP must have also increased by 27.8 percent between 1998 and 2006.
Question 6
Order Government Debt and Deficits
a) See the figure below.
b) The stance of fiscal policy is best measured by the change in the cyclically adjusted
deficit (which is a shift of the budget deficit function). A rise in the CAD reflects an
expansionary fiscal policy; a fall reflects a contractionary fiscal policy. Thus U.S. fiscal
policy was expansionary from 1989 through 1993, as the CAD increased from 2.9% to
3.7%.
c) After 1993, U.S. fiscal policy was quite contractionary, as the CAD fell from 3.7% in
1993 to 1.0% in 1997.
d) U.S. fiscal policy began its contraction in 1993, and the CAD fell by 2.7 percentage
points between 1993 and 1997. Canadian fiscal policy (combined governments) also began
its contraction in about 1993, but the dramatic contraction did not really begin until 1995.
From 1995 to 2000, the CAD in Canada declined by approximately 6 percentage points.
Thus the Canadian fiscal contraction was considerably sharper than the one in the United
States (reflecting, in part, the perception that the deficit was a larger problem in Canada
than in the United States).
Question 8
a) At E1 there has been an increase in both real GDP and the price level. On both counts
there will be an increase in the demand for money. If the money supply is unchanged
during this fiscal expansion, the excess demand for money will push up interest rates
relative to those that existed at E0.
b) The higher interest rate tends to reduce the amount of desired investment expenditure.
Recall that we assume desired investment to be autonomous with respect to the level of real
GDP.
c) The inflationary output gap at E1 implies that factor markets are in a state of excess
demand. This drives wages and other factor prices up and causes the AS curve to shift up
and to the left. At the new long-run equilibrium, real GDP is back to Y* but the price level
is higher than at E0. So we know that the demand for money and thus interest rates are
higher at E2 than at E0. Desired investment expenditure is therefore lower at E2 than at E0.
This is the crowding out of investment by the fiscal expansion.
d) In the long run (or perhaps the very long run), the reduction in investment caused by the
fiscal expansion implies that the economy’s capital stock is not rising by as much as it
otherwise would have. Thus, the long-run growth path of Y* will be reduced. For example,
instead of Y* growing by 3 percent per year, it might now be growing by only 2.5 percent
per year.
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