What is crowding out?
How can an increase in the government budget deficit lead to a change in the trade deficit?
Explain how the government can adjust its behavior in response to a decrease in tax revenue.
How does the debt-to-GDP ratio relate to the real interest rate? Explain.
How might budget deficits affect long-term economic growth?
Explain Ricardian equivalence.
Why are many economists skeptical about the validity of Ricardian equivalence?
1.Crowding out refers to when government must finance its spending with taxes and with deficit spending, leaving businesses with less money and effectively crowding them out. One explanation of why crowding out occurs is government financing of projects with deficit spending through the use of borrowed money. Because the government borrows such large amounts of capital, its activities can increase interest rates. Higher interest rates discourage individuals and businesses from borrowing money, which reduces their spending and investment activities. 2. Increase in government budget deficit will lead to trade deficit surplus as they are considered to be as twins. 3. Government adjust its behavior in response to a decrease in tax revenue by either decrease in government expenditure or by decrease in imports. 4. Debt-to-GDP ratio depend on real interest rate . An increase in real interest rate will result in increase in debt and also decrease in GDP as investment decreases , both will result in increasing in debt to GDP ratio. 5.A budget deficit is when a govt spends more money then it receives in revenue . This is creation of debt which will need to be paid off at a date in the future.If a budget does not balance, future earnings will need to be sacrifices to repay those debts, so in the long run capital that could have been used to create growth has to be set aside and used in debt repayments thus leaving less capital to use for growth. 6.An economic theory that suggests that…
hen a government tries to stimulate demand by increasing debt-financed government spending, demand remains unchanged. This is because the public will save its excess money in order to pay for future tax increases that will be initiated to pay off the debt. This theory was developed by David Ricardo in the nineteenth century, but Harvard professor Robert Barro would implement Ricardo’s ideas into more elaborate versions of the same concept. 7. One issue at hand here is the idea of Ricardian equivalence, which essentially posits the claim that there is no fundamental difference between spending financed by deficits or taxation. Suppose that the government increases spending. It follows that they must either tax current economic agents or issue government bonds to pay for the increased spending. The intuition behind Ricardian equivalence is that when the government increases spending individuals recognize that, even if the spending is financed through government borrowing, the spending creates an increase in their future tax liability.