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Economics: Theory Through Applications

This chapter explores the difference between the budget deficit and national debt, the impact of fiscal policy on the deficit, the factors that influence government budget deficits, and the effects of deficits on interest rates and GDP. It also examines the government budget constraint, the concept of crowding out, and the Ricardian theory.

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Economics: Theory Through Applications

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  1. Economics: Theory Through Applications

  2. This work is licensed under the Creative Commons Attribution-Noncommercial-Share Alike 3.0 Unported License. To view a copy of this license, visit http://creativecommons.org/licenses/by-nc-sa/3.0/or send a letter to Creative Commons, 171 Second Street, Suite 300, San Francisco, California, 94105, USA

  3. Chapter 29Balancing the Budget

  4. Learning Objectives • What is the difference between the deficit and the debt? • What are the links between the deficit and the debt? • What are the budget constraints faced by the government? • How does fiscal policy affect the budget deficit? • How does the state of the economy affect the budget deficit? • How do we determine if a budget deficit is because of fiscal policy or the state of the economy?

  5. Learning Objectives • When do countries run government budget deficits? • Why might a country incur a government budget deficit? • What is the crowding out effect? • When is crowding out effect of government deficits large? • What is the Ricardian theory about the effects of deficits on interest rates and real GDP? • What is the evidence on the Ricardian theory?

  6. Budget Deficit: Definition

  7. Table 29.1 - Calculating the Deficit

  8. Figure 29.1 - The Government Sector in the Circular Flow

  9. Table 29.2 - Recent Experience of Deficits and Surpluses (Billions of Dollars)

  10. Table 29.3 - On-Budget, Off-Budget, and Total Surplus, 2010 (Billions of Dollars)

  11. Table 29.4 - Federal Outlays, 2010 (Billions of Dollars)

  12. The Intertemporal Government Budget Constraint

  13. Linking the Debt and the Deficit

  14. Table 29.5 - Deficit and Debt

  15. Figure 29.2 - US Surplus and Debt, 1962–2010

  16. Figure 29.3 - US Surplus and Debt as a Fraction of GDP, 1962–2010

  17. Table 29.6 - Foreign Holdings of U.S. Treasury Securities as of August 2008 (Billions of Dollars)

  18. Who Holds the Debt?

  19. Figure 29.4 - Government Spending

  20. Taxation

  21. Figure 29.5 - The Tax Function

  22. Table 29.7 - Tax Receipts and Income

  23. Table 29.8 - Deficit and Income

  24. Figure 29.6 - Government Spending and Tax Receipts

  25. Figure 29.7 - Deficit/Surplus and GDP

  26. Figure 29.8 - Expansionary Fiscal Policy

  27. Figure 29.9 - The Cyclically Adjusted Budget Deficit

  28. Figure 29.10 - Cyclical Deficit

  29. Figure 29.11 - Structural Deficit

  30. Figure 29.12 - Balanced-Budget Requirement

  31. Figure 29.13 – Recession with a Balanced-Budget Amendment

  32. Figure 29.14 - Ratio of US Debt to GDP, 1791–2004

  33. Table 29.9 - Budget Deficits Around the World, 2005*

  34. Figure 29.15 - The Financial Sector in the Circular Flow

  35. The Credit Market

  36. Figure 29.16 - The Credit Market

  37. Figure 29.17 - Crowding Out

  38. Crowding Out

  39. Table 29.10 - Investment, Savings, and Net Exports (Billions of Dollars)

  40. The Household’s Lifetime Budget Constraint

  41. Figure 29.18 - Ricardian Equivalence

  42. Figure 29.19 - U.S. Surplus/GDP Ratio and Real Interest Rate, 1965–2009

  43. Figure 29.20 - U.S. Government and Private Savings Rates

  44. Figure 29.21 - Government and Private Savings Rates in Spain and Greece

  45. Figure 29.22 - Government and Private Savings Rates in France and Ireland

  46. Key Terms • Government deficit: The difference between government outlays and revenues • Government outlays: Government outlays equal government purchases of goods and services plus transfers • Government revenues: Money that flows into the government sector from households and firms, largely through taxation, is called government revenues • Government purchases: Government purchases equals spending by the government on goods and services

  47. Key Terms • Transfers: Transfers are cash payments from the government to individuals and firms • Examples are unemployment insurance and Medicaid payments • Government surplus: The government surplus is equal to total tax revenues collected by the governments less its purchases of goods and services and transfers to households • Government budget constraint: The government budget constraint says that the deficit must be financed by issuing government debt • Government debt: The stock of government debt is the total outstanding obligations of a government at a point in time

  48. Key Terms • Intertemporal budget constraint: According to the government’s intertemporal budget constraint, the discounted present value of outlays, excluding interest on the debt, minus the discounted present value of taxes must equal the current stock of debt outstanding • Primary deficit: The primary deficit is the difference between government outlays excluding interest payments and government revenues • Primary surplus: The primary surplus is the negative of the primary deficit

  49. Key Terms • Fiscal policy: Fiscal policy refers to changes in taxation and the level of government purchases, typically under the control of a country’s lawmakers • Exogenous variable: An exogenous variable is determined outside the model and is not explained in the analysis • Expansionary fiscal policy: Increases in government purchases or reductions in tax rates are called expansionary fiscal policy • Contractionary fiscal policy: Decreases in government purchases or increases in tax rates are called contractionary fiscal policy

  50. Key Terms • Cyclically adjusted budget deficit: The cyclically adjusted budget deficit is the difference between outlays and revenues calculated under the assumption that the economy is operating at potential GDP • Potential output: Potential output is the amount of real GDP the economy produces when the labor market is in equilibrium and capital goods are not lying idle

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