1. You are appointed secretary of the treasury of a recently independent country
ID: 1248554 • Letter: 1
Question
1. You are appointed secretary of the treasury of a recently independent country called Rugaria. The currency of Rugaria is the lav. The new nation began fiscal operations this year and the budget situation is that the government will spend 10 million lavs and taxes will be 9 million lavs. The 1-million-lav difference will be borrowed from the public by selling 10 year government bonds paying 5 percent interest. The interest on the outstanding bonds must be added to spending each year, and we assume that additional taxes are raised to cover that interest. Assuming that the budget stays the same except for the interest on the debt for 10 years, what will be the accumulated debt? What will size of the budget be after 10 years?Explanation / Answer
Government Spending(G) = 10 millions. Taxes= 9 millions. Budget deficit= Governnment spedning - Taxes = 10 - 1 = 1 million. Budget size= 10 millions 1 million bonds were issued at 10 yrs maturity and 5% interest rate. Future value of this amount if interest is added back to the principle every year. FV= PV( 1+i)^n FV= future value PV present vaue= 1 million i= interest rate @5%= 0.05 FV= 1 ( 1 +0.05)^10 = 1.63 millions. 1 million bonds will become 1.63 millions after 10 years Interest amount= 1.63 - 1 million =0.63 millions. Interest amount is collected by way of taxes. additional Taxes = 0.63 millions this amount should be paid to the bond holders. So, there will be an increase in budget size by 0.63 Tota budget Size = 10 +0.63 = 10.63 millions Government spending= 10 millins + 0.63 millions (interest payments) Revenue= 9.63 + 1 million= 10.63
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