What is Government Budget Constraint?

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Assume that the legislative branch of the government has in place an expenditure program. We can model this program as a pair (g1, g2). Notice that when one speaks of ‘an increase in government spending,’ one has to be careful to specify whether this increase is temporary, anticipated, or permanent.

Exactly how the government’s expenditure program is to be financed is a problem that falls on the government’s finance department (e.g., the Department of Finance in Canada; the Treasury Department in the United States; and the Ministry of Finance in Japan).

Finance departments typically have only one way in which to secure the resources necessary to finance the government’s demand for goods and services: taxes. While the finance department can also secure resources by borrowing (i.e., by issuing government bonds), to the extent that these bonds are eventually repaid, they simply constitute future taxes. Consequently, the problem facing a finance department basically boils down to one of choosing the appropriate timing of taxes.
 
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