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Saturday Quiz – November 20, 2010

Welcome to the billy blog Saturday quiz. The quiz tests whether you have been paying attention over the last seven days. See how you go with the following five questions. Your results are only known to you and no records are retained.

1. A nation that has a strong terms of trade (and external surplus) is able to run a budget surplus without necessarily forcing the private domestic sector into deficit. It is sensible under these conditions to invest the surpluses in a sovereign fund which creates more space for non-inflationary public spending in the future.

2. A sovereign national government, that is, one that issues its own floating currency faces no solvency risk with respect to the debt it issues.

3. Under current institutional arrangements, the change in the ratio of public debt to GDP will exactly equal the primary deficit plus the interest service payments on the outstanding stock of debt both expressed as ratios to GDP minus the changes in the monetary base arising from official foreign exchange transactions conducted by the central bank.

4. It would be impossible for a central bank to directly purchase treasury debt to facilitate the national government’s budget deficit (that is, "monetise the deficit") while still targeting a positive short-term policy rate.

5. Premium Question: Assume the government increases spending by $100 billion in the each of the next three years from now. Economists estimate the spending multiplier (which is the multiple by which income increases for a given injection of spending) to be 1.5 and the impact is immediate and exhausted in each year. They also estimate that the import propensity is 0.2 (meaning that imports rise by 20 cents for every dollar generated in the economy). They also estimate the tax multiplier (impact of tax changes on income) to be equal to 1 and the current tax rate is equal to 30 per cent. So for every extra dollar produced, tax revenue rises by 30 cents. Which of the following statements is correct?

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    This Post Has 2 Comments
    1. Here is a quote from the MMT website: “Most importantly, there is no solvency risk for the alchemist – only a pseudo form of default via currency collapse (hyperinflation). The alchemist only debases her gold when she issues an amount of gold that is in excess of productive capacity (inflation).” This makes a great deal of sense and I completely agree.

      What happens on the ground in a currency collapse is not “pseudo” – it is actual, catastrophic harm to people. A fear of a currency crash (whether sudden or not) is the force driving asset price inflation. The fear is that, however it may happen, there will be so many dollar bills floating around that everyone will lose confidence in the dollar as a store of value and will either require many more of them or will not accept them at all.

      Another fear is that the govt. is helping insiders – who will get the “highest value” of issuances of new money (before the ensuing inflation drives prices up for everyone else), or is providing inside information on monetary policy. Insiders who knew that the govt. would pour billions or trillions into the banks made a killing when it actually happened. Over time, more and more citizens will believe that the govt. is corrupt and this will have many harmful effects on society and productivity.

      “You have to have inflation before you can get hyper-inflation”. That’s like saying you have to have a stock market decline before you can have a crash. True enough, but things can cascade down horribly fast in this world.

      This is my first exposure to MMT and I’m fascinated by it. I understand that the processes of monetary policy are important. But I’m concerned that you don’t spend enough time on the obligation of a govt. to preserve a unit of currency as a store of value and as a substitute for the goods that it is intended to buy.

      Also, if you believe that a market that tends to be “free” is better than one that tends towards being “managed”, why do you believe that more “management” on the monetary policy side is a good thing? The people making those decisions are humans, prone to error and bias, and sometimes are corrupt. Why not apply the same “free market” thinking to monetary policy?

      Thank you.


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