7QQMM201: MACROECONOMICS
GEORGIOS CHORTAREAS
Professor of Economics
King’s College London
Lecture 8
Fiscal Policy, Debt, and Deficits
READINGS: See page 5
Introduction
KBS 7QQMM201 Lecture 8 2
Last lecture:
Optimal Monetary Policy
in Backward-Looking Models
in Forward-Looking Models
Interest rate rules
Time-inconsistency
Rules vs Discretion
The institutional design of monetary policy
KBS 7QQMM201 Lecture 8 3
Today’s topics – Outline
The Government Budget Constraint
Debt Sustainability
Ricardian Equivalence
Seignorage
Political-Economy Theories of Budget Deficits
KBS 7QQMM201 Lecture 8 4
Readings
(**)=Required readings, (*)=strongly suggested reading
(no *)= optional reading
Romer (2018):
Chapter 12, pp. 642-645(**),
Chapter 13, pp. 660-666(**), 669–673 (**), 678-682(**), 691(**).
Mankiw (2016)
Chapter 19: pp. 555-559(*), 564–575(**)
References to
Optional Readings
are provided in the
text.
KBS 7QQMM201 Lecture 8 5
I. The Government Budget
Constraint
KBS 7QQMM201 Lecture 8 6
Government Spending
Ratio of Public Spending to GDP
Source: Public Spending in the 20th century, V Tanzi, L. Scheknecht.
KBS 7QQMM201 Lecture 8 7
Government Spending
KBS 7QQMM201 Lecture 8 8
Government Spending
KBS 7QQMM201 Lecture 8 9
Plus the 1.9 TRILLION dollar covid relief bill
The Government Budget Constraint
The government’s budget constraint:
the present value of purchases of goods and services must
be less than or equal to its initial wealth plus the present
value of its tax receipts (net of transfer payments).
Let G(t) and T(t) denote the government’s real
purchases and taxes at time t, and D(0) its initial real
debt outstanding. (all variables are as defined in the textbook)
The limit of the present value of govt debt must be
negative, or (13.1) is equivalent to
KBS 7QQMM201 Lecture 8 10
( )
( ) ( )
( )
( )
(13.1) ,0 00 dttTeDdttGe t
tR
t
tR
=
−
=
−+−
( )
( )
(13.2) ,0lim
−
→ sDe sR
s
The Government Budget Constraint
The govt budget deficit: the rate of change of the
debt stock.
The rate of change in the stock of real debt is
We can use the primary deficit to rewrite the govt
budget constraint, (13.1), as
KBS 7QQMM201 Lecture 8 11
( ) ( ) ( )
( ) ( )
(13.3) ,
deficitprimary
tDtrtTtGtD +−=
( )
( ) ( )
( )
(13.4) .0
0DdttGtTe
t
tR −
=
−
A simpler approach:
The budget deficit (inflation-adjusted deficit) equals
spending, including real interest payments on the
The Government Budget Constraint
