As we noted earlier, when a government runs a budget deficit, it finances the deficit by issuing new debt. The stock of debt is linked directly to the government budget deficit. If, for example, the current stock of debt is zero, then the intertemporal budget constraint says that the discounted present value of future primary surpluses must equal zero. Because we are adding together flows in the future, we have to use the tool of discounted present value. This condition means that the debt outstanding today must be offset by primary budget surpluses in the future. Specifically, it is the requirement that current debt outstanding = discounted present value of future primary surpluses. The intertemporal budget constraint says that if a government has some existing debt, it must run surpluses in the future so that it can ultimately pay off that debt. The primary surplus is minus the primary deficit and is the difference between government revenues and government outlays, excluding interest payments on the debt. The primary deficit is the difference between government outlays, excluding interest payments on the debt, and government revenues. To express the intertemporal budget constraint, we introduce a measure of the deficit called the primary deficit. It borrows by issuing more government debt (government bonds). When a government runs a deficit, it typically borrows to finance it. Although governments can borrow or lend in a given year, a government’s total spending over time must be matched with revenues. Tax and spending decisions at different dates are linked. Intertemporal Government Budget Constraint A government surplus is sometimes called government saving. When a government runs a surplus, these funds flow into the financial markets and are available for firms to borrow. When a government runs a deficit, it must borrow from the financial markets. government surplus = −government deficit. In other words, a negative government deficit is the same as a positive government surplus, and a negative government surplus is the same as a positive government deficit. When outflows are less than inflows, then we say a government is running a surplus. Often, we find it useful to group taxes and transfers together as “net taxes” and separate out government purchases, as in the last line of our definition. government deficit = outlays − revenues = government purchases + transfers − tax revenues = government purchases − (tax revenues − transfers) = government purchases − net taxes. The circular flow of income tells us that any difference between government purchases and transfers and government revenues represents a government deficit. Money flows out in the form of outlays: government purchases of goods and services and government transfers. In any given year, money flows into the government sector, primarily from the taxes that it imposes on individuals and corporations. The Single-Year Government Budget Constraint
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