Saturday Quiz – April 9, 2011

1. When there is an external deficit, the private sector can reduce its overall indebtedness as long as the government supports saving by running a deficit.

2. Taxation is an essential part of a fiat monetary system and allows the national government to spend.

3. When a sovereign government issues debt it has no impact on the overall holdings of assets held by the non-government sector.

4. 10-year bond yields in Japan and the US have risen slightly in the last week suggesting that bond markets are demanding increased risk coverage for these assets.

5. Premium question: Many countries are facing higher public debt to GDP ratios as a consequence of the crisis and some are approaching 100 per cent. Assume the current public debt to GDP ratio is 100 per cent and that central banks keep nominal interest rates and inflation constant and zero. The proponents of fiscal austerity say that by running primary surpluses they can reduce the public debt to GDP ratio even if they create a short-term recession and invoke the automatic stabilisers (which push the budget towards deficit). However, they also claim that it is likely that their strategy will promote growth. The austerity strategy cannot reduce the debt ratio (under our assumptions) if a recession results.