Lecture 8

• An ageing population will be a significant future fiscal problem
• the climate emergency will create significant future fiscal drags
• the climate emergency will require significant publicly funded incentives to promote green investment and discourage negative externalities
• the climate emergency will require large infrastructure investments, which will require government fiscal support
• Inequality in the UK and US is very high, and will be a big fiscal problem in the future
• in order to manage the expected future increases in government spending, increases in taxes and rethinking intergenerational accounting is necessary
• social security is funded through employment taxes on a pay as you go system, but with an ageing population, the ratio of workers to retirees will fall, so taxes will need to increase or benefits will need to fall
• Health spending is increasing in all advanced economies
• health spending is increasing because consumption has diminishing returns, but the benefits (extra time to live/ enjoy higher incomes) are not, so health spending will rise by more than consumption
• healthcare expenditure will increase as income increases, so as countries get richer, they spend more on health
• High and rising Debt-to-GDP levels imply higher tax rates on future generations, but the policies that require higher debt may benefit these generations
• generational accounting calculates the extent to which current policies pass on tax burdens to future generations
• during wars, generational accounting is used because debt to GDP rose significantly, but raising taxes on the people who suffered during the war would be unfair
• The national income identity states that investment equals total saving
• the national income identity is that Y - C - G +(IM-EX) = I
• the national income identity states that if private and foreign saving doesnt change, increases in government spending will cause investment to decrease
• Ricardian equivalence implies the timing of taxes doesnt affect consumption, so deficits should not crowd out inflation, as consumers think about future tax rises, so will save more now to compensate
• the extent to which budget deficits crowd out investment is debated
• crowding in involves increases increases in deficits increasing demand within the economy (increasing Y), which increases investment
• consequences of taking on government debt requires considering economic growth, possibility of high inflation, intergenerational equity, and the crowding out nature debt has on investment
• debt to gdp ratios fall when r < g+pi ; interest rate is less than the nominal growth rate of the economy (real growth rate + inflation). It involves outgrowing the debt
• debt to GDP reduce even when public debt is increasing when growth is greater than debt
• if lenders stop lending to governments, the government must spend more money to finance debt, or print money to fulfil the budget, which creates inflation
• if debt to GDP gets too high, lenders worry about the ability of governments to repay, and investors may demand higher interest rates (or stop lending)
• if a government defaults, they declare that they will not repay certain debts, or will repay them below face value
• in the EU, debt to GDP increased but became more sustainable, because interest rates were falling. this also happened during Covid
• the flow version of the government budget constraint holds in each period
• the flow version of the government budget constraint is that Gt + Trt + iBt = Tt + change Bt+1 + change Mt+1
• Trt is transfer payments, so benefits and pensions
• Gt is government purchases, so spending on goods and services (education, healthcare)
• the flow version of the government budget constraint states that the sources of funds to the government must equal the uses of funds
• Tt is tax
• iBt is the interest rate * stock of debt, which is the interest payments on debt
• change in Bt+1 is new borrowing
• change in Mt+1 is change in the money stock (monetisation of debt)
• monetisation of debt and having the central bank give the government money can be inflationary, so is illegal to do in many countries
• the primary deficit is Gt - Tt, and excludes spending on interest
• the total deficit is Gt + iBt - Tt and includes interest payments
• the intertemporal budget constraint states that the governments budget must balance, but in PDV, so the timing doesnt matter, as long as the government has primary surpluses in the future to pay off current deficits
• the intertemporal budget constraint states that uses must equal sources of government spending, in Present Discounted Value