# Paper #1 Debt and Deficits

Paper #1 Debt and Deficits

ECN 3300 Public Finance Fall 2018 Assignment #1 Debt and Deficits Due by the end (EDT) of Sunday, September 9, 2019. 1. (10 points) Structural deficits. a. (1 point) Go to https://fred.stlouisfed.org/ Enter “W019RC” in the search box. Click on “Quarterly, Seasonally Adjusted Annual Rates”. Move your mouse pointer across the graph to find the amount of total spending in the second quarter of 2011 (Q2 2011). What was it? b. (1 point) Repeat the process using “W018RC” in the search box. (Alternatively, while still looking at the federal expenditures graph, click on “Edit Graph”, click on “Add Line” near the top, enter “W018RC” in the search box, click on the first “Federal government total receipts, then click on “Add data series”.) What was the size of the federal government’s total receipts in the second quarter of 2011?* c. (2 points) Using these data, what was the size of the federal government’s deficit in the second quarter of 2011? d. (2 points) Now suppose that if the U.S. economy had been at full employment, federal government total expenditures would have been only \$3600 billion and federal government total receipts would have been \$3100 billion. What was the size of the federal government’s cyclical deficit? e. (2 points) Using the assumptions in part d, what was the size of the federal government’s structural deficit? f. (2 points) In your opinion, why did the federal government total receipts fall so much between 2007 and 2009? * The spike in receipts in the fourth quarter of 2017 is interesting but it was just a one-time event. It was the result of wealthy Americans responding to the passage of the Tax Cut and Jobs Act of 2017. The TCJA eliminated some tax breaks, so it was better for some taxpayers to shift taxes from 2018 to 2017.

2. (10 points) Ricardian equivalence. Suppose the market interest rate on 20-year bonds is 7%. Also suppose that the federal government borrows \$2 billion by selling 20-year zero-coupon bonds for \$2 billion today. (The current market values of these bonds add up to \$2 billion. Because these are zero-coupon bonds, the government only makes one payment on each bond â€“ the payment when the bonds mature in 20 years.) a. (2 points) In Figure 4-4 in the textbook, which curve shifts because the government sells a \$2 billion bond? Which way does it shift, to the right or to the left? By how much does it shift? b. (2 points) How much will the government have to pay 20 years from now to pay off the bond? c. (2 points) What if today’s consumers say to themselves, “We need to be ready to pay the taxes the government will need to raise when it pays off the bond in 20 years. We need to set aside enough money today so that in 20 years that money, plus the interest it will earn, is enough to pay the taxes the government will have to impose then.” What is the present value of the future cost (from part b) of paying off the bond? d. (2 points) As a result of this additional saving, which curve in Figure 4-4 shifts? Which way does it shift, to the right or to the left? By how much does it shift? e. (1 point) What is the net effect of the government’s borrowing on today’s interest rate? f. (1 point) In your opinion, do consumers behave this way when the government announces that it will borrow more? Briefly explain your answer.

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