1 / 16

Lecture 22: Public Debt I

Lecture 22: Public Debt I. L11200 Introduction to Macroeconomics 2009/10. Reading: Barro Ch.14 22 March 2010. Introduction. Last time: effect of different forms of taxation on real activity Labour income and asset income taxes both proved ‘distortionary’

jrodger
Download Presentation

Lecture 22: Public Debt I

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Lecture 22: Public Debt I L11200 Introduction to Macroeconomics 2009/10 Reading: Barro Ch.14 22 March 2010

  2. Introduction • Last time: effect of different forms of taxation on real activity • Labour income and asset income taxes both proved ‘distortionary’ • Cost to society was lower output and income • Today: the ‘public budget’ • Governments’ budgets and debt

  3. Public Debt • So far, considered how government raise income (tax) and spend revenue • Governments can also amass assets / incur debts • Call the government’s budget position the ‘public budget’ • U.K./U.S. governments currently have large public deficits (expenditure > income) and also large public debts.

  4. Government Bonds • Government can borrow by issuing ‘bonds’ • An i.o.u. from the government, bought by households • So households can either buy private bonds, or government bonds • In aggregate, Bt=0, so aggregate household bond holdings are equal to

  5. Government Budget Constraint • Previous government budget constraint • With borrowing/saving this becomes government spending + government transfers = tax revenue + real revenue from money creation spending + transfers + interest payments = tax revenue + real debt issue +real revenue from money creation

  6. Government Budget Constraint • If Mt and Pt do not change over time, simplifies to: • If , government is saving, and vice-versa • So real government saving given by:

  7. ‘National Saving’ • So saving of an economy is given by: • Total private saving (household lending to other households cancels out) • Total private capital investment • Government saving • So government saving and private saving cancel out (just a flow of money between the two)

  8. Public Debt and Household Budget • Household multiyear budget constraint: • Now add household government bond holding present value of consumption = value of initial assets + present value of wage incomes + present value of transfers net taxes present value of consumption = value of initial assets + present value of wage incomes + present value of transfers net taxes

  9. Government Borrowing and Taxation • Now assume government has zero debt, and no transfers but decides to lower taxes without lowering spending • With no debt or transfers, government has no initial interest payments, so

  10. Government Borrowing and Taxation • In period 2, government repays all of its debts • For simplicity, assume borrowing was 1 unit • So, interest due is r multiplied by ‘1’, bond to be repaid is ‘1’: • Hence:

  11. Impact on households • How does this impact on households? • T1 falls by 1, T2 rises by 1+r • Present value Decrease in year 1’s real taxes + present value of increase in year 2’s taxes

  12. Debt Neutrality • So effect of cutting taxes, then increasing taxes again is 0 • Household pay lower tax in the first period • But then have to pay higher taxes in the second period • No change to present value (cost of debt interest offset by present value deduction)

  13. Ricardian Equivalence • This famous result is known as ‘Ricardian Equivalence’ • Households view a cut in real taxes as equivalent to an increase in the real budget deficit, and hence higher future taxation • So the real budget deficit is equivalent to the present value of real future tax rises

  14. Crucial Result for Public Policy • Ricardian Equivalence implies • Cutting taxes now to finance government spending has no impact on the economy – households ‘internalise the debt’ save more now • Borrowing more now to finance government spending has no impact on the economy – households anticipate tax rises and save more now

  15. ‘Fiscal Stimulus’ • No role for a fiscal stimulus • Idea: government should borrow and spend more now to ‘keep up demand’ during a recession • Problem: government borrowing means future tax rises for households • Households anticipate this, and save more now • Net effect (we have shown) is zero

  16. Summary • Government has an asset/debt position, just like households • Debts eventually have to be paid-off by lower spending or more taxation • Households know this, and offset govt activity • Next time: intertemporal effects • Taxes distorted output decision • Intertemporal tax/spend policy distorts household activity as well

More Related