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Lecture 7

Lecture 7 - Budget Deficit

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Simon Fraser University
ECON 105
Eldar Sehic

Budget Deficit Primary Budget Deficit (PBD): Recall that primary budget is given by: PB = T – G PBD = G – T = G – (TR – TP) = G – TR + TP = G o tY Changes in G o Example: PBD(?) = G (↑) – tY(↓) o Immediate effect of changing G isouncertain (on PBD) Changes in t: Example: PBD(?) = G – o(↑)Y(↓) Immediate effect of changing t is uncertain (on PBD) Changes in Y: Example: PBD(↑) = G – to(↓) Austerity: keeping G and TP low which has uncertain effects on PBD PBD = G – TR + TP = G -otY Budget Deficit (BD) BD = PBD + Debt-Service Payments BD = PBD + iD when D = Public Debt BD = G – T + iD = G – TR – TP + iD BD = G – tY + iD o BD and Debt: Gov’t borrows the amount not covered by its total Revenue BD = Borrowing = ∆D(debt) If BD > 0, then D ↑ If BD < 0, then D ↓ If BD is positive and it rises (from 20 to 30) then debt rises more (from 800 to 830 instead to 820) If BD is negative and it rises and is still negative (from -30 to -20) then debt falls less (from 800 to 780 instead of to 770) If BD ↑ then there is upward pressure on debt ------------830 ↑ -------------820 ________800 -------------780 ↑ -------------770 If BD is positive and it falls and is still positive (from 30 to 20) then debt rises less (from 800 to 820 instead of to 830) If BD is negative and it falls (from -20 to -30) then debt falls more (from 800 to 770 instead of to 780) If BD ↓ then there is downward pressure on debt ----------------830 ↓ --------------820 ________800 -------------780 ↓ -------------770 Debt-to-GDP Ratio (d) d = Debt/GDP = D/y Growth Rate of d = ∆d/d ∆d/d = ∆D/D - ∆y/y Ricardian Equivalence Non-Ricardian Consumers feel wealthier when government lowers taxes (increases borrowing) Ricardian consumers do not feel wealthier when government lowers taxes (increase borrowing) Interest Rate and Borrowing Nominal Interest Rate (i): what we see Real Interest Rate (r): true cost of borrowing and true benefit of lending r = i – π (Inflation Rate) i = r + π Higher borrowing pushes r up Output Gaps Recessionary Gap (Y < Y*): P
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