Define the following terms and explain their importance to the study of macroeconomics:

Question

a. structural budget deficit
b. monetize the deficit
c. crowding out
d. inflation accounting
e. mix of fiscal and monetary policy

Answer 1

a. The structural budget deficit is the hypothetical deficit that would occur with current fiscal policies if the economy were operating near full employment. It is a hypothetical number, in that it is based on assumed conditions. In a recession, the actual budget deficit is much larger than the structural budget deficit; at the peak of a business cycle, the actual budget deficit may be below the structural budget deficit.
b. The central bank is said to monetize the deficit when it purchases the bonds that the government issues. While this tends to hold down interest rates, it can also lead to rapid inflation if too much money is created too quickly.
c. Crowding out occurs when deficit spending by the government forces private investment spending to contract. If crowding out occurs, the expansionary effects of a budget deficit are substantially diminished.
d. Inflation accounting means adjusting standard accounting procedures because inflation lowers the purchasing power of money. Inflation distorts the government budget under conventional accounting procedures by exaggerating interest expenses. To correct the deficit for inflation, we must subtract the inflation premium from the interest paid on the national debt, thereby counting only real interest payments.
e. The mix of fiscal and monetary policy is the total stimulative or contractionary effect of the two major tools taken together. Fiscal and monetary policy can be used together to expand or contract, or can be in conflict, that is, working in opposite directions.