Pay-as-you-go (PAYGO) = no free lunch rule: if the government wants to spend more or cut taxes, it must immediately pay for it by raising other taxes or cutting other spending so the deficit doesn’t rise.
2. ACTUAL DEFICIT/ SURPLUS = STRUCTURAL DEFICIT/ SURPLUS + CYCLICAL DEFICIT/ SURPLUS
- Recession: Actual > Structural
- Boom: Actual < Structural
3. The primary deficit is defined as the deficit excluding interest payments. Including interest payments defines the total or headline deficit.
4. Headline deficit is the total gap between government spending and revenue. Primary deficit is the same gap but ignoring interest on existing debt.
5. The CFA curriculum emphasizes that the headline (overall) deficit is a poor measure of fiscal stance because it does not distinguish between:
- discretionary policy vs automatic stabilizers, and
- current decisions vs inherited debt-service costs
6. The fiscal multiplier is defined as the ratio of the change in equilibrium output to the change in autonomous spending. Why autonomous? Because only autonomous spending changes shift the aggregate demand curve; induced spending changes just move us along the existing AD curve.
$$ \mathrm{Fiscal\ Multiplier} = \frac{\Delta Y}{\Delta G} = \frac{1}{1 - MPC} $$
7. Government debt is a stock variable representing the accumulation of past deficits, whereas the budget deficit is a flow variable measured over a period of time.
8. The Ricardian Equivalence hypothesis suggests that a debt-financed tax cut will significantly stimulate current private saving. Rational consumers anticipate that lower taxes today imply higher taxes in the future to service the debt, prompting them to save the tax cut.
DIFFERENCE BETWEEN AUTONOMOUS AND INDUCED SPENDING
Autonomous spending is independent of current income levels, e.g., government spending, investment spending, exports. This can be created artificially. Induced spending varies with income, e.g., consumption and imports. This is natural. More income implies more consumption and imports.
BALANCED BUDGET MULTIPLIER
- Government raises spending by +1 → aggregate demand +1
- Taxes rise by +1 → disposable income falls by
- Consumption falls by only c × 1, not 1
- Net initial impact on AD: 1 -c
- This positive shock then multiplies through the economy Final result: Balanced Budget Multiplier= 1
BALANCED BUDGET MULTIPLIER
An economy has a marginal propensity to consume of 0.8 and a tax rate of 0.25. If the government increases spending by 100 while simultaneously increasing taxes by 100 to maintain a balanced budget, the immediate impact on aggregate output will be:
Increase in AD = +100 Fall in consumption = - (MPC × (1 - tax rate) × increase in taxes = - (0.8 × (1 - 0.25) × 100) = -60 Net initial impact on AD = 100 - 60 = +40