6 . Deficit and debt

1. 6. Deficit and debt • The government budget balance (fiscal balance) is the difference between revenues and spending over the course of an accounting period (usually one year) • (+) surplus and (-) deficit • Fiscal policy refers to the use of the government budget to influence economic activity • Different stances: neutral, expansionary, contractionary

2. 6. Deficit and debt • Funding the government expenditures: • Taxation • Seignioriage • Borrowing money • Consumption of fiscal reserves • Sale of fixed assets (e.g., land)

3. 6. Deficit and debt • The primary deficit is the difference between spending and taxes, and is given by: • Gt – Tt • The total deficit adds the interest payments on the debt: • rDt-1 + Gt – Tt • The debt is an accumulation of yearly deficits: • Dt = (1+r)Dt-1 + Gt – Tt

4. 6. Deficit and debt • Some related concepts: • The fiscal gap: the difference between spending and revenues over the long run (as % GDP) • Ricardian equivalence: families anticipate policies and the effects are thus cancelled • Crowding out effect: a deficit that is financed by increased borrowing can increase interest rates and then reduce private investment

5. 6. Deficit and debt • Fiscal multiplier: the ratio of a change in national income to any change in spending (private investment, consumer spending, government spending, or by foreigners) that causes it. When this multiplier exceeds one, the enhanced effect on national income is called the ‘multiplier effect’. • Twin deficits: when an economy has a current account deficit and a fiscal deficit. The economy is borrowing from foreigners in exchange for foreign-made goods, leading to devaluation/depreciation that can be severe and sudden.