Question

Discuss the relationship between the actual budget surplus and the HEB (i.e., the high-employment or cyclically-adjusted budget surplus) immediately after the negative demand shock (i.e., in the short run), assuming they are equal before the shock occurs.  In other words, explain why one is larger than the other after the shock.  Your answer should consider both the case where the actual budget surplus is required to be zero and the case where there is no restriction on the actual budget surplus.   

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Answer 1

A government budget is a financial statement presenting the government's proposed revenues and spending for a financial year. The government budget balance, also alternatively referred to as general government balance, public budget balance, or public fiscal balance, is the overall difference between government revenues and spending. A positive balance is called a government budget surplus, and a negative balance is a government budget deficit. A budget is prepared for each level of government (from national to local) and takes into account public social security obligations.

The government budget balance can be broken down into the primary balance and interest payments on accumulated government debt; the two together give the budget balance. Furthermore, the budget balance can be broken down into the structural balance (also known as cyclically-adjusted balance) and the cyclical component: the structural budget balance attempts to adjust for the impact of cyclical changes in real GDP, in order to indicate the longer-run budgetary situation.

The government budget surplus or deficit is a flow variable, since it is an amount per unit of time (typically, per year). Thus it is distinct from government debt, which is a stock variable since it is measured at a specific point in time. The cumulative flow of deficits equals the stock of debt.

a. Budget Surplus:

Budget Surplus (BS) is the excess of the Government’s revenue (taxes) over its total expenditure, which consists of purchase of goods and services and transfer payments.

BS is a function of level of income, for a given, government expenditure, transfer payments and income tax.

Full-Employment Budget Surplus (Bs*):

Cyclically adjusted surplus (or deficit)/

high-employment surplus/

standardized budget surplus/

structural surplus.

It is the BS at full-employment level of income. The full-employment budget surplus (BS*) shows the budget-surplus (BS) at the full-employment level of income (Y*)

If budget surplus is used to measure the effects of Fiscal Policy, then the BS can change if there is a change in the Autonomous private spending.

1. Full-employment level means an unemployment rate of about 5 to 5.5%. This rate will differ depending on the assumptions made about the economy at full employment.

2. High-employment surplus is not a perfect measure of fiscal policy because fiscal policy involves a number of variables like the tax rate, transfers and Government purchases.