Week 9: Macroeconomics and Publi

1. Financing Options for government :  1) raise tax, 2) borrow money, 3) print money 4) cut spending

2. How business and investment can be affected by a nation's debt, public deficit or surplus ?

Business Manager

If the government run a high deficit, it will either raise tax or financing it via selling government bonds in private capital market.

  For raising tax, the business might face higher financial burden, and will be indirectly affected by lower customer spending ability due to high tax.

  For selling government bonds, company need to compete with the government for limited funds, thus the interest rate will raise which will result in the Business Investment Crow-out

Investors

If a country runs a chronic government deficit, this country must save higher proportion of tax revenue to serve this deficit funding. Thus, this country will have a higher default risk.

Thus, investors shall avoid such kind of government bond or at least hedge against such kind of default risk.

Also, the interest rate increase will result in the bond prices falls due to the inverse relationship between bond price and bond yield.

So, we shall pick up other country bonds to avoid the loss caused by the bond price falling.

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Debt-to-GDP (measures the ability of a country to produce or to pay off its debt.

Real deficit=nominal deficit- inflation rate* total debt.

Sometimes, when even though a country runs a nominal deficit, the inflation rate might erode the value and then the burden of the debt. This suggest that a country can lower its debt burden by increasing inflation rate.

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Structural VS Cyclical Deficit

Structural deficit would exist when the economics is at full employment output, while cyclical deficit attribute purely to growth below full employment output.

Week 9: Macroeconomics and Public Finance-Budget Deficit Dilemma

Okun's Law: For every 1% fall in unemployment, GDP increases by 2%.

Week 9: Macroeconomics and Public Finance-Budget Deficit Dilemma Week 9: Macroeconomics and Public Finance-Budget Deficit Dilemma

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Faced with deficit, the government has three options to finance itself by 1) raising taxes (which might be politically unacceptable) 2) issuing bonds in private sectors to borrow money, however, it might result in the "crow-out" in private sector which will offset the fiscal stimulus.  3) printing money.

Week 9: Macroeconomics and Public Finance-Budget Deficit Dilemma Week 9: Macroeconomics and Public Finance-Budget Deficit Dilemma Week 9: Macroeconomics and Public Finance-Budget Deficit Dilemma

The balanced budget multiplier=1, when we increase the government spending and tax with the same amount, the final economic expansion equals exactly the same amount of government spending.

Week 9: Macroeconomics and Public Finance-Budget Deficit Dilemma

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The Pros and Cons of budget deficit

Internal VS External Budget deficit

Week 9: Macroeconomics and Public Finance-Budget Deficit Dilemma

1. More debts means more taxes which will distort the resource allocation and lead to an efficiency loss.

2. Servicing debt redistribute income from poor to rich

Deficit is an investment for future or a burden of future generations ?

How budget deficit financed by selling bonds might result in the trade deficit ?

Selling bonds--> Interest rate increase--> Currency appreciation--> Trade deficit

Week 9: Macroeconomics and Public Finance-Budget Deficit Dilemma