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Government budget

Government budget. Budget deficits and debt. Recall, when we talked about national savings: T – G is not a budget surplus Because it is missing some items From the beginning, we talked about government in Canada as all levels of government combined

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Government budget

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  1. Government budget Budget deficits and debt

  2. Recall, when we talked about national savings: • T – G is not a budget surplus • Because it is missing some items • From the beginning, we talked about government in Canada as all levels of government combined • Where does money come from and where does it go? • Government purchases of goods and services G • Debt-service payments i × D • Transfers • Tax revenues • Borrowing

  3. Government’s budget constraint: • G + i × D + Transfers = Tax revenues + Borrowing • G + i × D = (Tax revenues – Transfers) + Borrowing • G + i × D = T + Borrowing • Where T = net tax • G + i × D – T = Borrowing • This Borrowing = budget deficit • If Borrowing < 0, budget surplus • The sum of the budget deficits = government debt D • Means ΔD = budget deficit = (G + i × D) – T • Government debt is a stock • Budget deficit is a flow • Budget deficit > 0, means ΔD > 0, debt increases • Budget deficit <0, i.e., surplus, means ΔD < 0, debt decreases

  4. There are two parts to the budget deficit • Debt cannot be changed by policies • G and T can be changed by policies • They are discretionary • G – T = primary budget deficit • Also called program spending • Shows the extent to which taxes cover the discretionary part of expenditure

  5. Characteristics of fiscal policy • Recall how we talked about fiscal policy with automatic stabilizers • Taxes decline if GDP declines • Transfers increase if GDP declines • Net taxes decline and increase with GDP • T = t × Y • G and i × D are not the functions of Y • But budget deficit = (G + i × D) – T • Thus the budget deficit function • Fiscal policy determines the position of the budget deficit function • Changes in GDP mean moving along a fixed budget deficit function

  6. Characteristics of fiscal policy • Changes in GDP mean moving along a fixed budget deficit function • Fiscal policy determines the position of the budget deficit function • More contractionary fiscal policy shifts the budget deficit function down • More expansionary fiscal policy shifts the budget deficit function up • We could look at the deficits and judge a policy • But there are changes in GDP • The CAD measures the deficit as if GDP = Y* • Also called structural deficit • Tells you about fiscal policy • Comparison of actual deficit and CAD tells you about business cycles

  7. Changes in debt-to-GDP ratio d • Canadian government tries to achieve a reduction in d • d = D/GDP • Then Δd = x + (r – g) × d • The debt-to-GDP ratio changes • If there is a primary budget deficit x • and/or if the debt accumulates faster than real GDP grows • To reduce the debt-to-GDP ratio • It is good to run primary budget surpluses • Spend on current programs less than collected in taxes • It helps if real interest rate r is low • It helps if the real economy grows at high rate g

  8. What do the deficits do to the economy? • Recall, increase in G => increase in GDP • AE = C + I + G + NX • Positive AD shock • But also, (T – G) = public savings • Then, increase in G => decrease in public savings • This leads to a decrease in national savings • Loanable funds theory of interest: • Decrease in national savings => increase in interest rate • This is crowding out private investments • In addition, increase in interest rate => decrease in NX • This is crowding out net export • This is referred to as long-term burden of government debt

  9. Is the long-term burden of government debt bad? • It depends: • Government invests (“better” than private sector) => we are better off • Government spends on current consumption => present generation benefits at expence of future generations • Is that bad? • Capital budgeting is a proposal to restrict borrowing to (“good”) investments only • Does Government Debt Hamper Economic Growth? Read --- not tested

  10. Formal fiscal rules • Annually balanced budget • Could not really achieve • Taxes and spending cannot be continuously adjusted • And likely a bad idea • Automatic stabilizers would be destroyed • Cyclically balanced budgets • What does it mean about the budget deficit function position? • Can you see the problem? • Formal fiscal rules are not generally followed but there is an understanding that the government strives to approach what they suggest

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