1
Intermediate
Macroeconomics
Lecture 12
2
Government Debt
? Scale of govern,debt
? Is budget deficit correctly measured?
? Traditional view of govern,Debt
? Ricardian equivalence
? Other possible effects of govern,debt
3
Scale of Govern,Debt
90
91 92 93 94 95 96 97 98 99 00 01 02 03
C h in a 6.14 8.58 10.46 13.2
F r a n c e 39.5 40.3 44.7 51.6 55.3 62.9 66.5 68.2 70 66.2 65.4 65 66.7 68.4
G e r m a n y 41.5 38.8 41.8 47.4 47.9 57.1 60.3 61.8 63 61.2 60.5 60.2 62.4 63.7
J a p a n 64.6 61.1 63.5 69 73.9 80.4 86.5 92 103 115.8 123.4 132.6 142.7 151
Ta iw a n
25.57 28.66 28.92 31
U,S, 66.6 71.4 74.1 75.8 75 74.5 73.9 71.4 68 65.3 59.5 59.7 60.7 62
U,K, 44.4 44.3 49.2 58.1 55.8 60.6 60.1 60.5 62 56.3 51.5 50.7 50.8 50.6
?OECD Economic Outlook 72 (Dec,2002)
?http://www.economist.com
4
Is Budget Deficit correctly measured?
1,Inflation
Real govern,debt stays the same
(100 apple,$1 each)
price rises 50%
? Nominal govern,debt becomes $150
? $50 deficit
Current method tends to overstate deficit when
there is inflation
5
Is Budget Deficit correctly measured?
2,Capital Assets
Government’s assets and liabilities should
be considered (capital budgeting)
budget deficit = change in liabilities - change in assets
Hard to decide which expenditures should
count as capital expenditures…
6
Is Budget Deficit correctly measured?
3,Uncounted liabilities
Current measure excludes some important
govern,liabilities
e.g,pensions of govern,workers
social security system
contingent liability
7
Is Budget Deficit correctly measured?
4,Business cycle
Recession,
Tax income decreases
Transfer increases
Budget deficit increases
Change in budget deficit depends not only on
govern,policies,but also on business cycle
8
The Traditional View of Govern,Debt
? Short-run
Y
E
Y
r
E=C(Y-T)+I+G
Y=E
LM
IS
9
The Traditional View of Govern,Debt
Tax cut
?Consumption increases
?Output increases
10
The Traditional View of Govern,Debt
? Long-run
I,S
r
k
y
I
S=Y-C(Y-T)-G
i=sf(k)
k?
11
The Traditional View of Govern,Debt
Tax cut
?Consumption increases
?National savings decrease
?Interest rate increases
?Investment decreases
?Lower steady state k and y
12
The Ricardian View of Govern,Debt
? The basic logic of Ricardian Equivalence
Consumers are forward-looking,
Consumption does not depend on current
income alone,but depends on life-time
income
13
The Ricardian View of Govern,Debt
Financing the govern,by debt is equivalent
to financing it by tax
--- Ricardian Equivalence
Private savings + public savings unchanged
The tax cut does not have any effect that
traditional analysis predicts,
14
The Ricardian View of Govern,Debt
? However,the Ricardian equivalence does not
imply that all changes in fiscal policy are
irrelevant,
The tax cut is accompanied by the announcement
that the government will decrease its future
purchase
? Consumers would expect that there might not be
future tax increase,so that C increases…
15
The Ricardian View of Govern,Debt
?The govern,budget constraint
If the govern,sells bonds at pd1 to finance its
deficit without cutting purchase
11 TGD ??
DrGT )1(22 ???
)11)(1(22 TGrGT ????
r
GG
r
TT
????? 1
21
1
21
16
The Ricardian View of Govern,Debt
? Defenders of the traditional view believe
that future taxes do not have as large an
influence on current consumption as the
Ricardian view assumes,
17
The Ricardian View of Govern,Debt
1,Myopia,people are short-sighted
2,Borrowing constraints
3,Future generations
(Robert Barro,people save for their future
generations ? consumers time horizon is
infinite)
18
Other Views of Govern,Debt
1,Effects on monetary policy
2,Debt and political process
3,International effects
Intermediate
Macroeconomics
Lecture 12
2
Government Debt
? Scale of govern,debt
? Is budget deficit correctly measured?
? Traditional view of govern,Debt
? Ricardian equivalence
? Other possible effects of govern,debt
3
Scale of Govern,Debt
90
91 92 93 94 95 96 97 98 99 00 01 02 03
C h in a 6.14 8.58 10.46 13.2
F r a n c e 39.5 40.3 44.7 51.6 55.3 62.9 66.5 68.2 70 66.2 65.4 65 66.7 68.4
G e r m a n y 41.5 38.8 41.8 47.4 47.9 57.1 60.3 61.8 63 61.2 60.5 60.2 62.4 63.7
J a p a n 64.6 61.1 63.5 69 73.9 80.4 86.5 92 103 115.8 123.4 132.6 142.7 151
Ta iw a n
25.57 28.66 28.92 31
U,S, 66.6 71.4 74.1 75.8 75 74.5 73.9 71.4 68 65.3 59.5 59.7 60.7 62
U,K, 44.4 44.3 49.2 58.1 55.8 60.6 60.1 60.5 62 56.3 51.5 50.7 50.8 50.6
?OECD Economic Outlook 72 (Dec,2002)
?http://www.economist.com
4
Is Budget Deficit correctly measured?
1,Inflation
Real govern,debt stays the same
(100 apple,$1 each)
price rises 50%
? Nominal govern,debt becomes $150
? $50 deficit
Current method tends to overstate deficit when
there is inflation
5
Is Budget Deficit correctly measured?
2,Capital Assets
Government’s assets and liabilities should
be considered (capital budgeting)
budget deficit = change in liabilities - change in assets
Hard to decide which expenditures should
count as capital expenditures…
6
Is Budget Deficit correctly measured?
3,Uncounted liabilities
Current measure excludes some important
govern,liabilities
e.g,pensions of govern,workers
social security system
contingent liability
7
Is Budget Deficit correctly measured?
4,Business cycle
Recession,
Tax income decreases
Transfer increases
Budget deficit increases
Change in budget deficit depends not only on
govern,policies,but also on business cycle
8
The Traditional View of Govern,Debt
? Short-run
Y
E
Y
r
E=C(Y-T)+I+G
Y=E
LM
IS
9
The Traditional View of Govern,Debt
Tax cut
?Consumption increases
?Output increases
10
The Traditional View of Govern,Debt
? Long-run
I,S
r
k
y
I
S=Y-C(Y-T)-G
i=sf(k)
k?
11
The Traditional View of Govern,Debt
Tax cut
?Consumption increases
?National savings decrease
?Interest rate increases
?Investment decreases
?Lower steady state k and y
12
The Ricardian View of Govern,Debt
? The basic logic of Ricardian Equivalence
Consumers are forward-looking,
Consumption does not depend on current
income alone,but depends on life-time
income
13
The Ricardian View of Govern,Debt
Financing the govern,by debt is equivalent
to financing it by tax
--- Ricardian Equivalence
Private savings + public savings unchanged
The tax cut does not have any effect that
traditional analysis predicts,
14
The Ricardian View of Govern,Debt
? However,the Ricardian equivalence does not
imply that all changes in fiscal policy are
irrelevant,
The tax cut is accompanied by the announcement
that the government will decrease its future
purchase
? Consumers would expect that there might not be
future tax increase,so that C increases…
15
The Ricardian View of Govern,Debt
?The govern,budget constraint
If the govern,sells bonds at pd1 to finance its
deficit without cutting purchase
11 TGD ??
DrGT )1(22 ???
)11)(1(22 TGrGT ????
r
GG
r
TT
????? 1
21
1
21
16
The Ricardian View of Govern,Debt
? Defenders of the traditional view believe
that future taxes do not have as large an
influence on current consumption as the
Ricardian view assumes,
17
The Ricardian View of Govern,Debt
1,Myopia,people are short-sighted
2,Borrowing constraints
3,Future generations
(Robert Barro,people save for their future
generations ? consumers time horizon is
infinite)
18
Other Views of Govern,Debt
1,Effects on monetary policy
2,Debt and political process
3,International effects