MGEB06H3 Lecture Notes - Lecture 8: Government Budget Balance, Output Gap, Canada Social Transfer

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Macroeconomics Notes: Lecture Eight (Chapter Thirteen) PART2
A Cautionary Note: Lags in Fiscal Policy
In real life, fiscal policy can affect output with some time lags (we also called them policy lags)
the time between when the policy is decided upon and when it is implemented.
These time lags can take the following forms:
It takes time for the government to realize a shock has hit the economy.
It takes time for the government to develop a plan to respond to the shock.
It takes time for the change in fiscal policy to have an impact on the economy.
Implications:
With these policy/time lags, it is possible that by the time the change in fiscal policy takes
effect, the shock might already be over (i.e., the economy has recovered by itself).
If this is the case, changes in fiscal policy might lead to unnecessary fluctuations in output.
Multipliers effects of changes in government transfer and taxes:
Since the budget balance changes automatically when output changes, part of the budget balance
is ENDOGENOUS (having an internal cause or origin)! (SPublic = GBB = T TR G)
This implies we need to separate a deficit during a recession from a persistent deficit even
the economy is operating at full employment.
Structural deficit: The government runs a budget deficit even Y = YFE, this is bad!
Cyclical deficit: The GBB equals to 0 when Y = YFE, and the government runs occasional
budget deficit when the economy is in a recessionary gap. This is normal.
Ideally, the government should run surpluses during good times (when Y > YFE), and deficits
during bad times (when Y < YFE) such that the budget is balanced over time.
Deficits, Surpluses, and Debt
Relationship between budget balance and national debt:
National debtt = National debtt-1 Government budget balancet
National debtt = National debtt National debtt-1 = GBBt
Holding all else constant, when GBB > 0, national debt .
Holding all else constant, when GBB < 0, national debt .
Default and Debt in Practice
To assess the burden of national debt and/or a government’s ability to repay its debt, we look
at the debt-to-GDP ratio.
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The higher the debt-to-GDP ratio, the higher the burden of the national debt.
Implicit Liabilities
Implicit liabilities refer to spending promises made by government that are effectively a debt
despite the fact that they are not included in usual debt statistics. Examples include the Canada
Health Transfer, Old Age Security (OAS), Canada Social Transfer (CST) and others.
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Document Summary

In real life, fiscal policy can affect output with some time lags (we also called them policy lags) The time between when the policy is decided upon and when it is implemented: these time lags can take the following forms: It takes time for the government to realize a shock has hit the economy. It takes time for the government to develop a plan to respond to the shock. It takes time for the change in fiscal policy to have an impact on the economy. With these policy/time lags, it is possible that by the time the change in fiscal policy takes effect, the shock might already be over (i. e. , the economy has recovered by itself). If this is the case, changes in fiscal policy might lead to unnecessary fluctuations in output. Multipliers effects of changes in government transfer and taxes:

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