This is “End-of-Chapter Material”, section 14.6 from the book Theory and Applications of Macroeconomics (v. 1.0).
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We started this chapter by asking whether the United States should adopt a balanced-budget amendment to the constitution. This question has both political and economic ramifications.
It is not our purpose in this book to answer this question, or others like it, for you. Most interesting questions do not have easy answers. Instead, they come down to assessments of costs and benefits and judgments about which frameworks best describe the world that we live in. Our intent here was to provide you with the ability to assess the arguments about a balanced-budget amendment and, more generally, the effects of deficit spending on the economy.
We saw in this chapter that there are certainly both benefits and costs associated with deficit finance. Key benefits include the ability to spread out the payments for large government purchases and the opportunity to use deficits to stimulate economies in recession. The main cost of deficits is that they increase real interest rates, thus crowding out investment and slowing long-term growth.
As we also saw, these effects might be tempered by an increase in household savings in response to government deficits. The evidence suggests that the Ricardian perspective on deficits has partial validity. Changes in government savings are likely to be partially, but not completely, offset by changes in households’ saving behavior.
We also noted that a balanced-budget amendment would not absolve government of the difficult choices involved in balancing the budget. It is one thing to pass a law saying that the budget must be balanced. It is quite another to come up with the spending cuts and tax increases that are needed to make it happen.
Meanwhile, time is passing. Go and look again at the size of the debt outstanding reported at the US Treasury (http://www.treasurydirect.gov/NP/BPDLogin?application=np). How much has it changed since you first checked it? How much has your share of the debt changed?
Debate on balancing the budget:
The following table is a table of the same form as Table 14.1 "Calculating the Deficit" but with some missing entries. Complete the table. In which years was there a balanced budget?
Table 14.11 Calculating the Deficit
|Year||Government Purchases||Tax Revenues||Transfers||Net Taxes||Deficit|
The following table lists income and the tax rate at different levels of income. In this exercise the tax rate is different at different levels of income. For income below 500, the tax rate is 20 percent. For income in excess of 500, the tax rate is 25 percent. Calculate tax receipts for this case.
Table 14.12 Tax Receipts and Income
|Income||Marginal Tax Rate||Tax Receipts|
Consider the following table. Suppose that government purchases are 500, and the tax rate is 20 percent. Furthermore, suppose that real gross domestic product (GDP) takes the values indicated in the table. If the initial stock of debt is 1,000, find the level of debt for each of the 5 years in the table.
Table 14.13 Exercise
|Year||GDP||Deficit||Debt (Start of Year)||Debt (End of Year)|
The price of government debt during the Civil War makes for a fascinating case study. Both the Union and the Confederacy were issuing debt to finance their expenditures. Try to do some research on the value of Civil War debt to answer the following questions.
This exercise builds on Table 14.9 "Budget Deficits around the World, 2005*".