1. Suppose a government has no debt and a balanced budget. Suddenly it decides to spend $5 trillion while raising only $4.5 trillion worth of taxes.
(a) What will be the government's deficit?
(b) If the government finances the deficit by issuing bonds, what amount of bonds will it
issue?
(c) At a 4 percent rate of interest, how much interest will the government pay each year?
(d) Add the interest payment to the government's $5 trillion expenditures for the next year,
and assume that taxes remain at $4.5 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.