If the economy were operating at potential output Y P the budget balance would be SBB 0, the structural balance. The fiscal policy program is BB 0= t 0 Y– G 0. Estimates of structural budget balances in Canada are published by the Department of Finance in Fiscal Reference Tables, Tables 17 and 46, as 'cyclically adjusted budget balances'.įigure 7.7 illustrates the concept of the structural budget deficit as compared to the actual budget deficit. We need to look at a structural budget balance, calculated at potential output ( Y P) that is not changed by business fluctuations in actual output around potential output. The important point of these examples is that we cannot tell the stance of fiscal policy, or a change in the stance of fiscal policy, by looking at the budget balance reported by the Department of Finance and published in the media. With a tax rate of 0.20 and government expenditure of 200, the budget balance would be a surplus of 40. With government expenditure of G=200, BB=160–200=–40.Ĭonversely, suppose higher AE makes equilibrium output 1200. If, given other components of aggregate expenditure, the equilibrium output is 800, the actual budget balance will be a deficit. Holding these terms of the fiscal plan constant, as in Figure 7.4, the budget balance is a deficit at any income below 1000 and a surplus at any income above 1000. Using the previous numerical example, suppose government expenditure is 200 and the tax rate is 0.20. Notice that this structural budget function differs from the general budget function of Equation 7.5 by calculating net tax revenue at Y P rather than at any Y. Structural budget balance (SBB): the government budget balance at potential output. The structural budget balance provides a fiscal indicator that helps to solve this problem. Recent experience in Canada with oil prices and lower growth is a good illustration. Indeed, any change in non-government autonomous expenditure changes equilibrium income, net tax revenue, and the government's budget balance. In turn, this reduces net tax revenue and reduces the budget balance. Even if G and t are unaltered, a fall in investment or exports will reduce national income and output. In itself, the budget balance may be a poor measure of the government's fiscal stance, because the budget balance can change for reasons unconnected to fiscal policy. The net reduction in the deficit is less than the cut in G.īecause the observed budget balance combines autonomous ( G) and induced ( NT) components it is important to consider if the observed budget balance-whether surplus, balanced, or deficit-is a good measure of the government's policy action or fiscal stance.ĭoes the budget balance show whether fiscal policy is expansionary, aiming to raise national income, or contractionary, aimed at deficit control and reduction? The deficit is reduced but the austerity policy lowers autonomous aggregate expenditure and equilibrium national income from Y 0 to Y 1. \)Ī cut in government expenditure to reduce the budget deficit D 0 at Y 0 shifts the BB line up to BB 1.
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