Question

Macroeconomics: Intermediate Theory/ Calc-based

6. Fiscal debt can be defined as shown below. Suppose the tax structure is such that tax receipts Tx are lump sum. Suppose that the lump sum amount falls. Assume perfectly sticky short run prices in a standard IS/LM structure. Which of the following is true? Fiscal debt equation: B, = G + Tp = Ts¢ +(1+)Bt-1 Primary deficit rises; interest cost on the debt falls Primary deficit rises; interest cost on the debt rises Primary deficit falls; interest cost on the debt falls Primary deficit falls; interest cost on the debt falls A. B. c. D.

Answer 1

With lump sum taxes falling and everything else remaining the same , primary deficit ( Deficit excluding interest payments ) will rise and difference between government expenditure , transfers and tax revenue increases.

Fall in lump sum taxes will shift the IS curve to the right, this will increase the equlibrium interest rate to i' from i. Thus now at a higher interest rate , interest on the debt rises.

So answer will be B) Primary deficit rises, interest cost on the debt rises

Nate LM dulrut