Fiscal Policy

Fiscal policy
- automatic stabilizer: tax revenue, unemployment benefit
- discretionary policy

tax revenue is endogenous, sensitive to the state of economy than spending

fiscal policy is planned with horizon larger than monetary policy

fiscal consolidation may increase AD, eg. expansionry fiscal contraction
- people expect lower debt, lower taxes in future
- spending cut, wage cut -> labor cost down, Investment up , profit up
- structure reform complement fiscal contraction

Interaction of fiscal and monetary policy

use stackelberg game to model the interaction of policy makers

C- cooperation , Pareto efficient equilibrium 

OM -monetary leadership, OF -fiscal leadership

Government Budget Deficit

deficitt = rBt-1 + Gt -Tt
where r: real interest rate
    Bt-1: government debt at the end of year t-1

let deficitt = Bt - Bt-1
therefore:
Bt - Bt-1 = = rBt-1 + Gt -Tt
Bt = (1+r)Bt-1 + (Gt -Tt)

-if government spending is unchanged, a decrease in taxes today will have to be offset by an increase in taxes in the future.
-the longer the government waits to increase taxes, the higher the real interest rate, and higher the increase in future taxes

Debt to GDP Ratio

Bt/Yt = (1+r)Bt-1/Yt + (Gt -Tt)/Yt
after mathematics munipulation:
Bt/Yt - Bt-1/Yt-1 = (r-g)Bt-1/Yt-1 + (Gt -Tt)/Yt
where g: GDP growth rate

How countries reduced their debt ratios
- run budget surplus, (Gt -Tt) < 0
- have low real interest rate and high GDP growth, (r - g) > 0, real interest low can be low or even negative when inflation is high.
- a large part of the decrease in debt ratios was achieved by paying bond holders a negative real interest rate on the bonds

Balanced Budget

- It means Gt = Tt
If economy is good, T up -> G up -> cause overheating

If economy is not good, T down -> G down -> econ could not recover

Therefore, balanced budget is not practical

Ricardian Equivalence

David Ricardo developed a theory about government spending and private spending. When government stimulate demand bu debt financed spending, the people will save money to pat for future tax increases (to be used to pay off the debt).
- So overall demand is unchanged

Cyclically Adjusted Deficits

It is used to indicate whether tax/revenue system is going to create deficit at Yn (output at natural full employment). If it is negative at Yn, deficit is *not* going to go down.
- We never know exact Yn, and Yn changes, so Cyclically Adjusted Deficits is not useful

Money Finance
1. Debt Monetization
Fiscal dominance of monetary policy: Central bank must do what the government tells it to do. Government issues bonds and forces CB to buy. The central bank then pays the government with the money it creates, and the government uses that money to finance its deficit. This process is called debt monetization.

2. Seignorage
The amount of good and services that government can obtain by printing money. The revenue from money creation is called seignorage.

seignorage = ΔH/P = ΔH/H * H/P
seignorage/ Y =  (ΔH/H * H/P ) / Y

If government uses seinorage to finance budget deficit of 10% of GDP, seignorage/ Y = 10%, so ΔH/H = 10% and (H/P)/Y = 1,  the growth rate of nominal money must be 10%.