Another slideshow from
Ed Dolan’s Econ Blog
http://dolanecon.blogspot.com/
Structural Primary Balance
and Debt Dynamics
No...
November 28, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
Sustainable Fiscal Policy
What does it mean for fisc...
Variables of the Model
Let . . .
 GRO = growth rate of GDP
 EXP = government expenditures1
 REV = total tax revenue
 P...
Automatic fiscal stabilizers
 During a cyclical downturn, the
economy is said to have a negative
output gap
 Automatic s...
Current vs. Structural Budget Balance
 The current balance of the budget
is the measured value each year of
taxes minus e...
Structural Primary Balance
 A country’s Structural primary
balance (SPB) is the primary
budget balance that would exist
g...
Structural Primary Balance as an Indicator of Sustainability
 The structural primary balance is a
useful indicator of the...
Interest Rate vs. Growth Rate
 Typically (but not always) interest
rates on government debt run a
little higher than the ...
What Happens when Interest Rate > Growth Rate
If the interest rate R exceeds the
growth rate GRO, and assuming a
constant ...
Examples: Interest Rate < Growth Rate
If the interest rate R is less than the
growth rate GRO, then the ratio of
debt to G...
Conclusions
 For any initial ratio of debt to GDP (DEBT), interest rate (R), and GDP growth
rate GRO, there is an equilib...
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How do we Know if the Federal Debt is Sustainable?

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Discusses the sustainability of the federal debt using debt dynamics and the structural primary balance

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How do we Know if the Federal Debt is Sustainable?

  1. Another slideshow from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Structural Primary Balance and Debt Dynamics November 28, 2012 Terms of Use: These slides are made available under Creative Commons License Attribution— Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishers. Please go to the new version of this slideshow, posted on November 30, 2015 http://www.slideshare.net/dolaneconslide/tut orial-is-the-government-debt-out-of-control
  2. November 28, 2012 Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Sustainable Fiscal Policy What does it mean for fiscal policy to be sustainable? Possible answers: 1.Policy is sustainable as long as the government is solvent, that is, it can meet its financial obligations as they come due 2.It is sustainable if the ratio of debt to GDP does not grow without limit 3.Fiscal policy is sustainable if it follows rules and procedures that serve a rational public purpose This slideshow is concerned with the second meaning of sustainability, sometimes called “mathematical sustainability.” See Ed Dolan’s Econ Blog for Nov. 28, 2011 for a discussion of all three meanings Photo source: John Cummings, http://commons.wikimedia.org/wiki/File:US_Capitol_Buildin g,_sunset.JPG
  3. Variables of the Model Let . . .  GRO = growth rate of GDP  EXP = government expenditures1  REV = total tax revenue  PGMEXP = program expenditures, that is, all expenditures except interest  DEBT = government financial liabilities2  R = rate of interest on the debt  INT = interest expenditures = R*DEBT  OBAL = overall budget balance = (EXP-REV)  PBAL = primary budget balance  SPB = structural primary budget balance Notes: 1 All variables except R expressed as ratios to GDP 2 DEBT includes all of the government’s net financial liabilities to the private sector, including interest-bearing debt and monetary liabilities (currency plus bank reserve deposits at the central bank) Definition: The primary budget balance is the budget balance excluding interest expense PBAL = REV - PGMEXP PBAL = OBAL + R*DEBT
  4. Automatic fiscal stabilizers  During a cyclical downturn, the economy is said to have a negative output gap  Automatic stabilizers are budget elements that automatically move the budget toward deficit curing a cyclical downturn, for example: Income taxes Unemployment benefits  By adding to aggregate demand during downturns, automatic stabilizers moderate the business cycle
  5. Current vs. Structural Budget Balance  The current balance of the budget is the measured value each year of taxes minus expenditures  The structural balance (sometimes called the cyclically adjusted balance) is the current balance minus the contribution of automatic stabilizers  The structural balance shows what the current balance would be under current laws in force if the output gap were zero
  6. Structural Primary Balance  A country’s Structural primary balance (SPB) is the primary budget balance that would exist given current tax and expenditure laws if there were no output gap  The chart shows structural primary balances for 2011 for selected OECD members
  7. Structural Primary Balance as an Indicator of Sustainability  The structural primary balance is a useful indicator of the mathematical sustainability of fiscal policy  The equilibrium value of SPB required to maintain the debt-to-GDP ratio at a constant value on average over the business cycle depends on the initial debt-to-GDP ratio (DEBT), the rate of interest (R), and the rate of growth of GDP (GRO) To hold the debt ratio constant over the business cycle, the structural primary balance must equal the debt ratio times the difference between the interest rate on the debt and the rate of GDP growth SPB = DEBT*(R-GRO)
  8. Interest Rate vs. Growth Rate  Typically (but not always) interest rates on government debt run a little higher than the rate of growth of GDP  When that is the case, the structural primary balance must be held to a slight surplus to maintain a constant debt to GDP ratio
  9. What Happens when Interest Rate > Growth Rate If the interest rate R exceeds the growth rate GRO, and assuming a constant value for PBAL, the ratio of debt to GDP Remains constant if SPB=(DEBT*(R-GRO)) Grows without limit if SPB>(DEBT*(R-GRO)) Decreases without limit if SPB<(DEBT*(R-GRO)) Note: Negative value of debt indicates accumulation of assets in a sovereign wealth fund SPB=.005 SPB=.01 SPB=.015
  10. Examples: Interest Rate < Growth Rate If the interest rate R is less than the growth rate GRO, then the ratio of debt to GDP Remains constant if PBAL=DEBT*(R-GRO) Grows to a new limit if PBAL>(DEBT*(R-GRO)) Decreases to a new limit if PBAL<(DEBT*(R-GRO)) SPB= -.015 SPB= -.01 SPB= -.005
  11. Conclusions  For any initial ratio of debt to GDP (DEBT), interest rate (R), and GDP growth rate GRO, there is an equilibrium value of the structural primary balance SPB = (DEBT*(R-GRO)). If SPB begins at the equilibrium value and remains there, the debt-to-GDP ratio will remain constant  If the interest rate on government debt exceeds the growth rate:  The debt grows without limit if SPB is held at less than its equilibrium value  The debt eventually falls to zero and the government accumulates net assets if SPB is held above its equilibrium value,  If the interest rate is below the growth rate and SPB is held at a constant value , the debt ratio eventually reaches an equilibrium regardless of the starting values of the variables

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