Deficit, public debt and the shadow economy

Define public deficit and public debt, and explain their relationship: why is the deficit said to be a flow and debt a stock? Use the analogy of the tap and the bath.

A state spends $500.000$ million euros and receives revenue of $470.000$ million.

1. a) Calculate its annual deficit.
2. b) Explain where the state can get the difference from.

Distinguish between a budget surplus, balance and deficit. Calculate the balance of a state that receives $200.000$ million and spends $190.000$ million, and of another that receives the same and spends $215.000$ million. Which of the two will have to borrow?

Who lends money to the State? Explain what a Treasury bond or bill is, who usually buys them (banks, funds, individuals, other countries) and what the buyer receives in return (interest and repayment of the principal).

What is the risk premium? Explain in simple words what it measures (the extra interest investors demand from one country compared with the safest one) and what it indicates if it rises sharply.

What are the State's General Budgets and who approves them in Spain? Explain what they contain (the forecast of revenue and spending for the year) and why they are the most important economic law of the year.

A country accumulates a debt of $1.000.000$ million euros at an average interest rate of $3\ \%$.

1. a) Calculate annual interest expenditure.
2. b) Compare that figure with an education budget of $40.000$ million and draw a conclusion about the "cost" of the debt.

A country's public debt rises from $80\ \%$ to $100\ \%$ of its GDP, which is $1.200.000$ million euros.

1. a) Calculate the debt in euros at each moment.
2. b) Explain why the debt-to-GDP ratio can rise even if the annual deficit is falling: what role do the denominator (GDP) and the accumulated stock play?

A state has a debt of $100.000$ million euros at an average interest rate of $2\ \%$.

1. a) Calculate the annual interest expenditure.
2. b) If each year it pays that interest by borrowing new debt and repays nothing, explain what happens to the debt in the long run (the snowball effect) and why interest rates matter so much.

European fiscal rules ask countries to keep the deficit below $3\ \%$ of GDP and debt below $60\ \%$.

1. a) What do those rules seek (market confidence, sustainability, common discipline in a shared currency)?
2. b) What problem do they have in the middle of a recession (forcing cuts when the economy is weak: a pro-cyclical effect)? Reason through the debate.

Observe the budgetary data of a country during the first year of an economic recession:

• Real GDP falls by $3,2\,\%$.

• Tax revenue (personal income tax and VAT) decreases from $120.000$ to $106.000$ million euros.

• Spending on unemployment benefits increases from $14.000$ to $21.000$ million euros.

• The remaining public spending items remain frozen at $110.000$ million euros.

• The Government has not passed any tax laws or discretionary budgetary changes.

1. a) Demonstrate, using these data, how the automatic stabilizers have operated and calculate the change in the budget balance (deficit or surplus). What macroeconomic function do they serve regarding aggregate demand during the fall in GDP?
2. b) Suppose that the Minister of Finance, alarmed by the resulting deficit, decides to implement a procyclical policy by cutting public spending on healthcare and infrastructure to force an immediate budget balance. Predict the impact this decision will have on GDP, unemployment, and future tax revenue (paradox of thrift / paradox of austerity).
3. c) Distinguish between cyclical deficit and structural deficit in this scenario. Why can trying to eliminate the cyclical deficit through spending cuts worsen the crisis?

A country's Treasury announces a record issuance of public debt to finance its negative budget balance. Analyze the impact of this measure in two different macroeconomic contexts:

• Scenario A: The economy operates close to full employment ($4\,\%$ unemployment), private savings remain stagnant, and the Central Bank pursues a restrictive monetary policy to curb inflation.

• Scenario B: The economy goes through a deep recession ($19\,\%$ unemployment), there is high precautionary savings stagnant in banks, and the Central Bank maintains interest rates at $0\,\%$ with bond-buying programs.

1. a) Predict in which of the two scenarios a "crowding out" effect on private investment is highly likely to be triggered and in which one it is not. Justify the financial mechanism by explaining what will happen in each case to interest rates and credit to SMEs.
2. b) A commentator states: "Every public deficit automatically reduces private investment." Refute this statement drawing upon the concept of "crowding in" for Scenario B.
3. c) If you were the director of analysis at the Ministry of Economy, what three financial variables or indicators would you monitor to confirm whether public debt is crowding out the productive sector or not?

Explain what the shadow economy is and classify these situations depending on whether or not they belong to it: a plumber who charges cash without an invoice to avoid declaring it, a teenager who babysits their brother without pay, and a street vendor working without a license and without declaring income.

Analyse the causes and consequences of the shadow economy: why it arises (taxes, paperwork, habit) and what effects it has on tax revenue, business competition, and informal workers themselves.

A municipal report reveals that in a tourist town, $25\,\%$ of home renovation work and hospitality services is paid in cash without being declared. The spokesperson of a merchant association states: "In reality, this benefits the town: the client saves $21\,\%$ in VAT, the self-employed worker survives with lower costs, and that money is spent in local shops, boosting the economy."

1. a) Refute this argument from an economic standpoint: demonstrate what negative externalities and failures this practice generates regarding the sustainability of the welfare state, public accounts, and businesses operating legally.
2. b) One political party proposes reducing the shadow economy by lowering general tax rates, while another proposes tripling inspections and penalties. Predict the effects of both measures on the public deficit and tax compliance in the short and long term.
3. c) Design a fiscal measure based on conflicting interests between buyer and seller to bring undeclared activity to light voluntarily, justifying its feasibility.