##### Reference no: EM135803

Q. Suppose a government has no debt and a balanced budget. Suddenly it decides to spend $1 trillion while raising only $0.5 trillion worth of taxes.

1.What will be the government's deficit?

2. If the government finances the deficit by issuing bonds, what amount of bonds will it issue?

3. At a 3 percent rate of interest, how much interest will the government pay each year?

4. Add the interest payment to the government's $1 trillion expenditures for the next year, and assume that taxes remain at $0.5 trillion. In the second year, compute the

( i ) Deficit.

( ii ) Amount of new debt (bonds) issued.

( iii ) Total debt at end of year.

( iv ) Debt service requirement.

5. Repeat these calculations for the third, fourth, and fifth years, assuming that the Government taxes at a rate of $0.5 trillion each year and has noninterest expenditures of $1 trillion annually.

Year 3 Year 4 Year 5

Deficit

New Debt

Total Debt

Debt Service

6. What is the ratio of interest payments, relative to the deficit, with each passing year?

Year 2 Year 3 Year 4 Year 5

7. What will happen to the ratio of government debt to government expenditure with each passing year?