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Chapter 28: Problem 13

In which of the following cases does the size of the government's debt and the size of the budget deficit indicate potential problems for the economy? a. The government's debt is relatively low, but the government is running a large budget deficit as it builds a high-speed rail system to connect the major cities of the nation. b. The government's debt is relatively high due to a recently ended deficit- financed war, but the government is now running only a small budget deficit. c. The government's debt is relatively low, but the government is running a budget deficit to finance the interest payments on the debt.

Short Answer

Expert verified
Answer: Case C is the most concerning for the economy because the government has to run a budget deficit to finance interest payments on its debt, despite having low debt levels. This indicates potential problems in the economy or inefficient use of government funds that require further investigation.

Step by step solution

01

Case A: Low Debt and Large Budget Deficit for Infrastructure Project

In this scenario, the government's debt is relatively low, meaning that the country has a stable economic situation. However, the government is currently running a large budget deficit to finance a high-speed rail system project. While large budget deficits may cause problems in the long-term, in this case, it could lead to improvements in the country's infrastructure, enhance transportation, and potentially boost the economy.
02

Case B: High Debt Due to a War and Small Budget Deficit

In this case, the government's debt is relatively high due to a recently ended war that was financed through deficits. Now, the government is only running a small budget deficit. It is important to consider why the deficit is small and if the government is taking steps to address its high debt level. While high debt might be concerning, it is not uncommon for countries facing extraordinary circumstances such as a war. If the government is taking steps towards stabilizing its debt, the situation might not be problematic for the economy.
03

Case C: Low Debt and Budget Deficit for Interest Payments

In this scenario, the government's debt is relatively low, which is generally positive for the economy. However, the government is running a budget deficit to finance the interest payments on its debt. This indicates that the government is not generating enough revenue to cover its debt payments without running a deficit, which could be a sign of an underlying problem in the economy or an inefficient use of government funds. Based on these analyses, the most concerning case among the three for the economy is
04

Case C

. In this case, the government's debt level is low, but the lack of revenue to cover interest payments and the need to run a deficit for this purpose indicate potential problems for the economy that require further investigation.

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Most popular questions from this chapter

Show why a \(\$ 10\) billion reduction in government purchases of goods and services will have a larger effect on real GDP than a \(\$ 10\) billion reduction in government transfers by completing the accompanying table for an economy with a marginal propensity to consume \((M P C)\) of \(0.6 .\) The first and second rows of the table are filled in for you: on the left side of the table, in the first row, the \(\$ 10\) billion reduction in government purchases decreasesa. When government purchases decrease by \(\$ 10\) billion, what is the sum of the changes in real GDP after the 10 rounds? b. When the government reduces transfers by \(\$ 10\) billion, what is the sum of the changes in real GDP after the 10 rounds? c. Using the formula for the multiplier for changes in government purchases and for changes in transfers, calculate the total change in real GDP due to the \(\$ 10\) billion decrease in government purchases and the \(\$ 10\) billion reduction in transfers. What explains the difference? (Hint: The multiplier for government purchases of goods and services is \(1 /(1-M P C)\). But since each \(\$ 1\) change in government transfers only leads to an initial change in real GDP of \(M P C \times \$ 1\), the multiplier for government transfers is $M P C /(1-M P C) .)$

Your study partner argues that the distinction between the government's budget deficit and debt is similar to the distinction between consumer savings and wealth. He also argues that if you have large budget deficits, you must have a large debt. In what ways is your study partner correct and in what ways is he incorrect?

An economy is in long-run macroeconomic equilibrium when each of the following aggregate demand shocks occurs. What kind of gap-inflationary or recessionary- will the economy face after the shock, and what type of fiscal policies would help move the economy back to potential output? How would your recommended fiscal policy shift the aggregate demand curve? a. A stock market boom increases the value of stocks held by households. b. Firms come to believe that a recession in the near future is likely. c. Anticipating the possibility of war, the government increases its purchases of military equipment. d. The quantity of money in the economy declines and interest rates increase.

In 2014 , the policy makers of the economy of Eastlandia projected the debt- GDP ratio and the ratio of the budget deficit to GDP for the economy for the next 10 years under different scenarios for growth in the government's deficit. Real GDP is currently \(\$ 1,000\) billion per year and is expected to grow by \(3 \%\) per year, the public debt is \(\$ 300\) billion at the beginning of the year, and the deficit is \(\$ 30\) billion in 2014 . a. Complete the accompanying table to show the debt-GDP ratio and the ratio of the budget deficit to GDP for the economy if the government's budget deficit remains constant at \(\$ 30\) billion over the next 10 years. (Remember that the government's debt will grow by the previous year's deficit.) b. Redo the table to show the debt-GDP ratio and the ratio of the budget deficit to GDP for the economy if the government's budget deficit grows by $3 \%$ per year over the next 10 years. c. Redo the table again to show the debt-GDP ratio and the ratio of the budget deficit to GDP for the economy if the government's budget deficit grows by $20 \%$ per year over the next 10 years. d. What happens to the debt-GDP ratio and the ratio of the budget deficit to GDP for the economy over time under the three different scenarios?

How did or would the following affect the current public debt and implicit liabilities of the U.S. government? a. In 2003 , Congress passed and President Bush signed the Medicare Modernization Act, which provides seniors and individuals with disabilities with a prescription drug benefit. Some of the benefits under this law took effect immediately, but others will not begin until sometime in the future. b. The age at which retired persons can receive full Social Security benefits is raised to age 70 for future retirees. c. Social Security benefits for future retirees are limited to those with low incomes. d. Because the cost of health care is increasing faster than the overall inflation rate, annual increases in Social Security benefits are increased by the annual increase in health care costs rather than the overall inflation rate.
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