Question

Assume the following economy:

Y1 = $300 (billion)

G = $ 90b

T = 0.6Y.

Yf = potential GDP = $480b

Using the above information answer the following questions:

1. does the budget balance have a cyclical behavior? if it does, is the budget balance procyclical or countercyclical?
2. would our economy have a structural balance problem? explain your answer

Answer 1

The current income of 300 billion results in tax collection of 0.6*300 = 180 billion. However government expenditure is only 90 billion which indicates that there is a budget surplus of 180 - 90 = 90 billion. also note that government expenditure is fixed but tax collection depends upon income. This shows that the current budget surplus as a cyclical component. This is a pro cyclical because if the economy expands this budget surplus will increase.

There is structural balance problem as well because when the economy reaches its full employment output level tax collection becomes 0.6*480 = 288 billion however government expenditure remains unchanged which means even at full employment level there is a structural budget surplus.