Lecture 16: The Government's Budget Constraint

Flashcards covering the government's budget constraint, fiscal deficits, and the intertemporal budget constraint.

What are the two views about tax cuts discussed in the lecture?

View 1: Tax cuts generate fiscal deficits, leading to higher interest rates and crowding out investment.

View 2: Tax cuts lead to higher public debt, implying future tax increases, so households save the tax cut, leading to no change in consumption or interest rates.

What is Ricardian equivalence?

The idea that tax cuts today lead to tax increases in the future, causing households to save the tax cut to pay for future taxes, resulting in no change in consumption, interest rates, or investment.

What are the basic units considered in the two-period model?

The Government, Firms, and Households.

Define the primary fiscal deficit.

The difference between government spending and tax revenue (G_t-T₂₎ in a given period, indicating the amount that the government needs to borrow or finance through debt.

Define the secondary fiscal deficit.

The sum of the primary fiscal deficit and interest payments on government debt (Gt-T_t + r_t-1B_t-1).

What is government saving (S^g_t)?

The negative of the secondary fiscal deficit, or T_t - G_t - r_t-1B_t-1.

What is the government budget constraint in period 1, assuming B₀ = 0?

B₁ = G₁ - T₁

What is the government budget constraint in period 2, assuming B₂= 0?

T₂ - G₂ = (1 + r₁)B₁

What is the intertemporal budget constraint of the government?

G₂ + G/(1 + r₁) = T₁ + T₂/(1 + r₁)

If the government cuts taxes in period 1 without changing government spending, what must happen in period 2 to satisfy the intertemporal budget constraint?

The government must raise taxes in period 2 by ∆T2 = −(1 +r)∆T1 > 0.