Topic 13: Government Budget Deficit

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Topic 13 Government Budget Deficit

• Terminology and facts
• Govt expenditure and tax revenue diagram
• Stick to balanced budget may un-stabilize the
  economy
• Structural balanced budget and good fiscal policy
• Monetizing government deficit results inflation
• Reading Ch14

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Deficits and Debt Terminology and Facts

• Budget deficit is the amount by which the
  governments expenditure exceeds its receipts
  during a specific period of time, usually a year.
  
• Budget Surplus is the amount by which the
  governments receipts exceed its expenditure
  during a specific period of time, usually a year.
  
• National Debt is the federal governments total
  indebtedness at a moment in time. It is the
  result of previous deficits.

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Deficits and Debt Terminology and Facts
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Deficits and Debt Terminology and Facts

• Ever increasing debt and deficit since 1980s
  worried people
• The rule of balanced budget got promoted
• But this was not smart either
• Deficit is not necessarily a bad thing
• But if deficit is too high Crowd out private
  investment
• If debt is too high
• Print money to pay back interest and the
  principle is unavoidable

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Govt Expenditure and Tax Revenue Diagram
R tYT Government budget R - G
Spending and Tax Receipts
Equilibrium Gross Domestic Product
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Govt Expenditure and Tax Revenue Diagram
surplus decrease at any Y

• An increase in G _______________________

Spending and Tax Receipts
Eqm Gross Domestic Product
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Govt Expenditure and Tax Revenue Diagram
Surplus increases at any Y

• An increase in T _______________________

Spending and Tax Receipts
Eqm Gross Domestic Product
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Govt Expenditure and Tax Revenue Diagram

• An increase in t

Spending and Tax Receipts
Eqm Gross Domestic Product
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Analysis Stick to balanced budget may
un-stabilize the economy
Q Suppose the economy is at full employment and
govt budget is balanced. Now here comes an
adverse supply shock and the govt sticks to
balanced budget policy 1. Will the govt budget
in deficit or surplus? Ans In deficit. With
proportional tax, revenue decreases in recession
LRAS
GR
GR
AD
Eqm GDP
GDP
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Analysis Stick to balanced budget may
un-stabilize the economy
2. To have balanced budget, what will govt
do? Ans ? G, ? T, or ? t
GR
Eqm GDP
GDP
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Analysis Stick to balanced budget may
un-stabilize the economy
3. What is the result of govt action in 2? Shall
it stick to balancing budget? Ans AD shifts left
and deepens the recession. No!
LRAS
AD
AD
GR
GR
Eqm GDP
GDP
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Analysis Stick to balanced budget may
un-stabilize the economy
4. What shall the govt do as a response to the
adverse shock if it is necessary to close up the
recessionary gap quickly? How does the new fiscal
policy effect government budget? Ans Use
expansionary fiscal policy and bear the deficit
AD
LRAS
AD
GR
GR
AD
Eqm GDP
GDP
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Concerning budget deficit, a good fiscal policy
is

• A good fiscal policy is to have structural
  balanced budget. (i.e. budget balanced if at full
  employment)
• Structural budget deficit or surplus is the
  deficit or surplus we would have under current
  fiscal policy if the economy is in full
  employment.
• A fiscal policy with
• structural balanced budget
• Expect zero debt in the
• long run with such policy
• But not much room left for
• fiscal policy design

Budget balanced if at full employment
GR
Eqm GDP
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Monetizing government deficit results inflation

• Monetization is that the FED uses OMO to
  purchase government bond for financing
  governments budget deficit.
• When govt debt is huge, Monetization (Print
  money to pay back debt) is usually the choice
• Monetizing too much results hyperinflation
• Quantity theory of money
• MVPY ?
• ?M ?V ?P ?Y

MS1
MS2
MS3
MS4
MS0
r
Velocity
MD
M
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Topic 14 Basic of Exchange rate

• Exchange Rate states the price, in terms of one
  currency, at which another currency can be
  bought.
• Example Exchange rate from British pounds to a
  dollar is 0.71
• Appreciation A nations currency is said to
  appreciate as one unit of its currency cost more
  units of foreign currency
• Depreciation A nations currency is said to
  depreciate as one unit of its currency cost less
  units of foreign currency
• If dollar appreciates, US goods are more
  expensive
• Has effect to NX

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Currency appreciates if the economy booms

• If US economy booms, FED increase r
• Invest more in US
• Americans supply less dollars
• Foreigners demand more dollars
• Dollar appreciates
• ?r gt ?I and ?NX

Pounds
D
D
Dollars