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IV              Suppose the U.S. government began 2016 with no debt. The expenditures listed below do not...

IV              Suppose the U.S. government began 2016 with no debt. The expenditures listed below do not include interest on debt.

                 

                  2016: Spending on goods & services and transfers         $4.5 trillion

                              tax receipts                                                                                      $4 trillion

                  What is the budget deficit? How much must the Treasury borrow?

                  2017:   Expenditures and tax receipts both increase by 1% from the year before.

                               In addition, the debt incurred in 2016 has a 2% interest rate, which must be paid this year.

                  What is the budget deficit? How much must the Treasury borrow? What is its total debt?

                 

                  2018:   Spending and tax are same as 2017. Bonds issued in 2017 carry the same interest rate.

                  What is the budget deficit? How much must the Treasury borrow? What is its total debt?

                 

                  2019:   Spending is the same as 2018. But taxes increase 10% due to major expansion in macroeconomy. Bonds issued in 2018 carry the same interest rate. In addition, half of the                                         (cumulative) Treasury bonds mature this year.

                 

                  What is the budget deficit? How much must the Treasury borrow? How much in bonds must it issue?

Solutions

Expert Solution

2016

Budget Deficit = Tax receipts - Spending on goods and services and transfers

or, Budget Deficit = $4 Trillion - $4.5 Trillion = (-)$0.5 Trillion

So, the government needs to borrow $0.5 Trillion.

2017

Tax receipts = $4 Trillion + 1% x $4 Trillion = $4.04 Trillion

Spending = $4.5 Trillion + 1% x $4.5 Trillion = $4.545 Trillion

Interest on debt = $0.5 Trillion x 2% = $0.01 Trillion

Deficit = $4.04 Trillion - $4.545 Trillion - $0.01 Trillion = (-)$0.515 Trillion

Therefore, the treasury must borrow $0.515 Trillion.

Total debt = $0.5 Trillion + $0.515 Trillion = $1.015 Trillion

2018

Interest on debt = $1.015 Trillion x 2% = $0.0203 Trillion

Deficit = $4.04 Trillion - $4.545 Trillion - $0.0203 Trillion = (-)$0.5253 Trillion

Therefore, the treasury must borrow $0.5253 Trillion.

Total debt = $1.015 Trillion + $0.5253 Trillion = $1.5403 Trillion

2019

Tax receipts = $4.04 Trillion + 10% x $4.04 Trillion = $4.444 Trillion

Interest on debt = $1.5403 Trillion x 2% = $0.030806 Trillion

Debt maturity (or debt to be repaid) = $1.5403 Trillion / 2 = $0.77015

Deficit = $4.444 Trillion - $4.545 Trillion - $0.030806 Trillion - $0.77015 = (-)$0.901956 Trillion

Therefore, the treasury must borrow $0.901956 Trillion.

Total debt = $1.5403 Trillion - $0.77015 Trillion + $0.901956 Trillion = $1.672106 Trillion

jeff jeffy answered 2 years ago
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