1 / 7

FISCAL POLICY

FISCAL POLICY. D = i*B -1 + G – T D = today’s deficit G = Government Expenditure T = Tax Revenue i = interest payments on debt B -1 = Debt level inherited from yesterday D = B – B -1 (deficit is the additional debt). Government budget constraint. B = (1+i)B -1 + (G – T)

triage
Download Presentation

FISCAL POLICY

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. FISCAL POLICY D = i*B-1 + G – T • D = today’s deficit • G = Government Expenditure • T = Tax Revenue • i = interest payments on debt • B-1 = Debt level inherited from yesterday • D = B – B-1 (deficit is the additional debt)

  2. Government budget constraint • B = (1+i)B-1 + (G – T) • Consider a two-year model: • On year 1 Gov. borrows (accumulates debt) • On year 2 Gov. pays back its debt • On year two Gov. must satisfy B2 = 0: • B2 = 0 = (1 + i)B1 + (G2 + T2) • Gov. Must pay back debt with primary surplus (raise taxes or cut spending)

  3. Government Budget Constraint • If Gov wants to keep debt level constant (B2=B1) then primary surplus must equal i: • Accumulation of deficits leads to debt • To stabilize debt: contain primary deficit • Primary surplus must equal interest on debt to keep it stable. • Debt today means higher taxes tomorrow; or…

  4. Debt Sustainability • Debt may be sustained with higher growth Bt/Yt = (1+i) Bt-1/Yt +(Gt - Tt)/Yt Bt/Yt = (Yt-1/Yt-1)(1+i) Bt-1/Yt +(Gt - Tt)/Yt • Since Yt= Yt-1(1+g) where g is growth rate Bt/Yt = (1+i)/(1+g) Bt-1/Yt-1 +(Gt - Tt)/Yt

  5. Fiscal Sustainability • Ricardian Equivalence: consumers realize that a tax cut today implies more taxes tomorrow. • Consumer internalize this and adjust their spending • As Government saving falls, private savings compensates and increases

  6. Fiscal Sustainability • Full-employment deficit refers to the expected deficit when the economy is at its “natural” rate (is there such thing?) • Compare Italy’s growth rate with its natural rate. • Structural conditions may vary during a business cycle.

  7. Fiscal Sustainability • High debt alone does not imply unsustainable path (see Belgium) • High deficit alone does not imply unsustainable path (see Greece) • High debt, high deficit, and low growth is a bad recepy (see Italy).

More Related