Problems for Chapter 12
1.
What would happen to the budget deficit if the
a) GDP growth rate reduced from 4 percent to 2 percent?
b) Inflation increased by 3 percentage points?
2.
Suppose a government has no debt and a balanced budget. Suddenly it decides to
spend $15 billion while raising only $10 billion worth of taxes.
a) What will be the government’s deficit?
b) If the government finances the deficit by issuing bonds, what amount of bonds
will it issue?
c) At a 10% rate of interest, how much interest does the government pay each
year?
d) Add the interest payment to the government's $15 billion expenditures for the
next year, and assume that taxes remain at $10 billion. In the second year compute
the
i) Deficit
ii) Amount of new debt (bonds) issued.
iii) Debt-service requirement.
3.
Explain how the financing and refinancing of public debt might affect real interest
rates, private investment, the stock of capital and economic growth. What
circumstances might mitigate some of these effects?
4.
At the end of 2006 India’s expenditures of $144 billion exceeded their revenues
by $35 billion. It is interesting to note that India’s debt as of 1998 was $15 billion
at the end of 1998. Using the information below (in billions of US dollars), fill in
the blanks for India’s budget balance and debt for the following years:
1999
2000
2001
5.
Revenues
Expenditures
Debt
$5
_____
$10
$8
$12
____
____
$23
$22
Say the marginal tax rate is 40 percent and that government expenditures do not
change with output. Assume also that the economy is at potential (fullemployment) output and that the deficit is $100 billion.
a) What is the size of the cyclical deficit?
b) What is the size of the structural deficit?
c) How would your answers to a) and b) change if the deficit were still $100
billion but the output were $200 billion below potential?