Fiscal Policy:
Policy:
A Summing
Summing Up
Up
CHAPTER 26
Prepared by:
Fernando Quijano and Yvonn Quijano
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d e fic it t r B
t1
G t Tt
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d e fic it t r B
t1
G t Tt
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B B Deficit
t 1
d e fic it t r B
t1
G t Tt
B B rB G T
t
t 1
t 1
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B B rB G T
t 1
Bt B
Interest payments
t1
t 1
rB
Primary deficit
t1
G t Tt
Primary Deficit
B (1 r ) B G T
t
t 1
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(1 r ) B 1 ( G
T2 )
T2 G
(1 r )1 (1 r )
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t1
(1 r ) t2
B t (1 r ) B
t1
(G t Tt)
0 (1 r )(1 r ) t2 ( G t T t )
which implies that the necessary surplus in year t to repay
the debt must be:
Tt G
(1 r ) t1
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678
B 1 r B G T
PrimaryDeficit
From t
for year 2 is
t 1
(1 r ) B 1 ( G
T2)
1 (1 r ) ( G
T2)
T2 G
(1 r ) 1 r
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B
B G T
(1 r )
Y
Y
Y
t
t 1
Y B G T
B
(1 r )
Y
Y
Y Y
t
t 1
t 1
t 1
B
B G T
(1 r g )
Y
Y
Y
t 1
t 1
B B
B G T
(r g )
Y Y
Y
Y
t
t 1
t 1
t 1
t 1
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B
B
B
G T
(r g )
Y
Y
Y
Y
t
t 1
t 1
t 1
t 1
This took many steps, but this final relation has a simple
interpretation: The change in the debt ratio over time is equal
to the sum of two terms.
The first term is the difference between the real interest
rate and the growth rate times the initial debt ratio.
The second term is the ratio of the primary deficit to GDP.
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B B
B G T
(r g )
Y Y
Y
Y
t
t 1
t 1
t 1
t 1
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Ricardian Equivalence
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B B
B
(G T )
(r g )
Y Y
Y
Y
t
t 1
t 1
t 1
t 1
The higher the ratio of debt to GDP, the larger the potential
for catastrophic debt dynamics.
Expectations of higher and higher debt give a hint that a
problem may arise, which will lead to the emergence of the
problem, thereby validating the initial expectations.
Debt repudiation consists of canceling the debt, in part or
in full.
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Revenues
18.9
Personal taxes
7.9
2.9
6.8
Other
1.3
0.8
18.4
Consumption expenditures
6.1
Defense
Nondefense
4.1
2.0
Transfers
8.9
2.8
Other
0.7
0.5
2.2
0.8
1.4
-1.7
-0.3
37.0
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Figure 26 3
Deficits Projections:
Federal Government
Deficit, Fiscal Years
2007 to 2017
Under current fiscal rules, the
deficit turns into a surplus by
2012. Under more realistic
assumptions about spending
and revenues, however, it
increases steadily over the
period.
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The red line shows the projected path of the deficit under
the joint assumptions that discretionary spending will
increase with nominal GDP, that tax cuts will be extended,
and that the AMT will be indexed for inflation. Under these
assumptions, the deficit grows steadily larger, reaching
3.5% by 2017.
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2010
2030
2050
Social Security
4.2
4.2
5.9
6.2
Medicare/Medicaid
4.1
4.8
8.4
11.5
Total
8.3
9.0
14.3
17.6
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Key Terms
inflation-adjusted deficit
government budget
constraint
primary deficit (primary
surplus)
debt-to-GDP ratio, debt ratio
Ricardian equivalence,
Ricardo-Barro proposition
full-employment deficit
midcycle deficit
standardized employment
deficit
structural deficit
cyclically adjusted deficit
automatic stabilizer
tax smoothing
debt repudiation
Congressional Budget
Office (CBO)
baseline projections
entitlement programs
Social Security Trust Fund
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