Econ10003 lecture 8 PDF

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lecturer: Chris Edmon...

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Introductory Macroeconomics Lecture 8: fiscal policy (in ordinary times) Chris Edmond & Daeha Cho 1st Semester 2020

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Revised Schedule: Rest of Part I • Lecture 8 (March 30) fiscal policy in ordinary times • Lecture 9 (April 1) fiscal policy in extraordinary times • Extended Easter break April 6 – April 19 • Lecture 10 (April 20) monetary policy in ordinary times • Lecture 11 (April 22) monetary policy in extraordinary times • Lecture 12 (April 27) aggregate demand and supply, part one • Lecture 13 (April 29) aggregate demand and supply, part two

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Revised Schedule: Part II

• Then Daeha Cho takes over lectures

• Lectures 14 – 23, on long-run macro and open economy macro

• Last lecture for this subject is now June 3

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Revised Due Dates • Online multiple choice #1 April 2 to April 3 (this week)

• Online multiple choice #2 May 21 to May 22 (unchanged)

• Assignment #1 April 22 (pushed back after extended Easter break)

• Assignemnt #2 May 27 (pushed back)

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Fiscal Policy (in Ordinary Times)

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Rest of This Lecture • Fiscal policy in ordinary times

– basic fiscal policy concepts – more on fiscal policy and demand management – government budget constraint, debts and deficits

• BOFAH chapter 8

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Basic Fiscal Policy Concepts • Government decisions to spend, raise revenue, and issue debt • Expenditure – government purchases of goods and services schools, police, courts, military, roads – transfers to households and firms age pension, newstart, parental support – interest payments to holders of government debt • Revenue – personal and company income taxes, GST, excises, land taxes • Levels of government (commonwealth, state, local) 7

Government Expenditure Australia Major categories, 2017/18, billions of dollars

Defence Education Health Social protection Transport Economic affairs .. . Total

Commonwealth 32.0 37.3 76.8 158.9 9.4 20.7

Total 32.0 99.6 129.6 178.1 32.7 30.1

463.9

647.1

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Government Expenditure Across Countries

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Government Revenue Australia Major categories, 2017/18, billions of dollars

Income, profits and capital gains Payroll Property GST etc .. . Total

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Commonwealth 312.4 1.1 0.0 106.5

Total 312.4 24.7 30.3 141.5

427.2

528.6

Government Revenue Across Countries

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Fiscal Policy and Demand Management

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Fiscal Policy and Demand Management

• Keynes argued should use fiscal policy to stabilise business cycle

• Use G and T to offset temporary shortfalls in private spending

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Fiscal Policy and Demand Management

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Limits of Fiscal Policy in Demand Management • Possible side-effects – changes in taxes may distort incentives to work and invest – deficit-financed government spending may push up interest rates, ‘ crowding out ’ private sector investment • Practical concerns – lags in making and implementing decisions – lags between decision and time spending effects economy – tension between getting timing right and most worthwhile spending (e.g., infrastructure timing) – waste

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Government Budget Constraint

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Government Budget Constraint • Period-by-period government budget constraint

Gt + iBt + T ransf erst = T axes t + (Bt+1 − Bt ) | {z } | {z } uses of funds

sources of funds

where

Gt = government purchases of goods and services iBt = interest payments on existing government debt Bt+1 − Bt = change in government debt T ransf erst = transfer payments from government T axest = tax revenue • To simplify notation

Tt = T axest − T ransf erst = net taxes 17

Government Budget Constraint

• With Tt denoting net taxes (taxes minus transfers)

Gt + iBt = Tt + (Bt+1 − Bt )

• What is the relationship debt and the government deficit ?

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Debts and Deficits • The amount of government debt is Bt • Government deficit is the change in government debt

Bt+1 − Bt = Gt − Tt + iBt • Hence

deficit positive

Bt+1 − Bt > 0

⇔ debt increasing

deficit negative

Bt+1 − Bt < 0

⇔ debt decreasing

• Deficit is sum of primary deficit Gt − Tt plus interest payments iBt

on existing government debt 19

Government Deficits Relative to GDP

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Government Debt Relative to GDP

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Gross Debt vs. Net Debt

• More precisely, this is gross government debt

• What if we look at the asset side of balance sheet?

• Assets minus liabilities gives a measure of government net wealth

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Government Net Wealth Relative to GDP

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Can Governments Keep Accumulating Debt? • Government period-by-period budget constraint

Bt+1 − Bt = Gt − Tt + iBt

• Government borrowing today implies interest cost tomorrow

• To get complete complete picture, need to rollover the

period-by-period budget constraint • Result is the government’s ‘ intertemporal budget constraint ’

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Digression on Present Values • If interest rate is i > 0, present value of a dollar in t periods

✓

1 1+i

◆t

• Present value of a sequence {X} = {X0 , X1 , X2 , . . . } is

PV({X}) = X0 +

✓

1 1+i

◆1

◆t ∞ ✓ X 1 Xt = 1 + i t=0

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X1 +

✓

1 1+i

◆2

X2 + · · ·

Intertemporal Budget Constraint • With some algebra (omitted), government’s intertemporal budget

constraint can be written in the form B0 =

1 PV({T − G}) 1+i

• Government debt outstanding cannot be more than present value

of future primary surpluses – debt is current promise to make future payments – current deficit must be offset by future surpluses

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Next Lecture

• Fiscal policy in extraordinary times

– global financial crisis

– coronavirus pandemic

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