Lecture 23
BUDGET DEFICITS

1. The govt's budget constraint

• Receipts: Tax revenues (T)
  
  Actual value = $ ________ trillion.

• Outlays:
  • Spending on goods and services (G)
  • Transfer payments
  • Interest payments on debt:
    
    Value = $ ________ billion

  • Total outlays = $ ________ trillion.
  
  Note: Data available at the CBO website.

2. Measuring the budget deficit

• Definition:
  Budget deficit = Outlays - Receipts

• The current value of the budget surplus/deficit is $ __________ bn.

• As a proportion of GDP, the budget surplus/deficit is _______%.

• Borrow from the public:
  Issue Treasury bills, notes and bonds

• Increase money supply:
  Monetization of the deficit

3. National debt

• Sum of all past budget deficits

• Since 1980, an increase in the debt/GDP ratio

• About 40% of the debt is held by foreigners

• Key issue: Is the debt adding to the nation's productive capacity?

• Current debt/GDP ratio = _______%

4. Are budget deficits bad?

• Suppose govt. expenditure rises ...
  ...causing the budget deficit to increase

• From the goods market eqbm condition:
  
  GDP will [increase / decrease]
  Prices will [rise / fall]

• From the money market eqbm condition: Interest rates will [rise / fall]

• Private investment will fall (why?):
  
  This is called the crowding-out effect

• Smaller increases in future capital stock

• Reduced GDP growth in the future

• Suppose the govt cuts taxes today

• Consumers realize that taxes will be raised in the future (why?)

• To avoid lower consumption in the future ...
  ... they will save more today

• In the income-expenditure diagram, the consumption schedule will not shift up!

• Ergo: No change in GDP or interest rate!