Economics with Prof. Sanjay Paul
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 _______%.
2.1 Financing a deficit
How can the govt finance a budget deficit?
- 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?
4.1 Keynesian view
- 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
4.2 Ricardian equivalence principle
- 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!