1. If a government runs a deficit, it will ____________its outstanding debt.

2. Proponents of Ricardian equivalence are primarily concerned about deficits crowding out the stock of capital. ____________ (True/False)

3. When a central bank purchases new government bonds, it is ____________the deficit.

4. Historically, debt/GDP ratios increase during periods of ____________.

5. Debt and Deficits in Belgium. Here are some data for Belgium in 1989:

GDP: 6,160 billion Belgian francs

Debt: 6,500 billion Belgian francs

Deficit: 380 billion Belgian francs

Interest Rate on Bonds: 8.5 percent

Use the data to answer the following questions:

a. What are the deficit/GDP ratio and debt/GDP ratio? How do these ratios compare to the same ratios in the United States today? To what period in U.S. history does the debt/GDP ratio in Belgium correspond?

b. Approximately how much of the budget in Belgium is devoted to interest payments on its debt? If Belgium could wipe out its debt overnight, what would happen to its current budget deficit?

6. Interest Rates, Primary Surpluses, and Government Debt. The gap between taxes and spending, excluding interest on the debt, is known as the primary surplus. Suppose there is $100 million of outstanding public debt. Show that a primary surplus of $10 million with an interest rate of 10 percent has the same consequence for next year s debt level as a primary surplus of $5 million and an interest rate of 5 percent.

7. The Effects of Changing Entitlement Rules. How is a decrease in the age at which workers are eligible for Social Security similar to an increase in the government deficit?

8. Tax Smoothing or Strategic Tax Policy? Assume the pressures of an aging population and increases in health-care costs will increase total federal spending in the future significantly.

a. Under the theory of tax smoothing, what should happen to the current level of taxes if future spending is scheduled to rise?

b. Now suppose future spending increases are not inevitable and that, as a practical matter, you believe Congress will spend whatever revenue it collects. Would you still recommend tax smoothing?

9. Policy Options for the Federal Budget. The Web site for the Congressional Budget Office (www.cbo.gov) contains its projections for future budget surpluses and deficits as well as options for increasing the surplus. Using this site, find some options you think are desirable and that would have a significant effect on increasing the budget surplus.