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Saturday Quiz – April 23, 2011

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 six questions. Your results are only known to you and no records are retained.

1. Even Modern Monetary Theory accepts that continually expanding the money supply will inevitably be inflationary.



2. If there is an external deficit of 2 per cent of GDP and the government balances its budget then the private sector will have:




3. By draining funds out of the system, government borrowing from the private sector reduces the risk that public spending will overheat the economy.



4. A national government would be unable to rely on the central bank purchasing treasury debt to match its budget deficit (that is, "monetise the deficit") if the central bank is targeting a positive short-term policy rate.




5. Premium Question - In Year 1, the economy plunges into recession with nominal GDP growth falling to minus -1 per cent. The inflation rate is subdued at 1 per cent per annum. The outstanding public debt is equal to the value of the nominal GDP and the nominal interest rate is equal to 1 per cent (and this is the rate the government pays on all outstanding debt). The government's budget balance net of interest payments goes into deficit equivalent to 1 per cent of GDP and the debt ratio rises by 3 per cent. In Year 2, the government stimulates the economy and pushes the primary budget deficit out to 2 per cent of GDP and in doing so stimulates aggregate demand and the economy records a 4 per cent nominal GDP growth rate. All other parameters are unchanged in Year 2. Under these circumstances, the public debt ratio:







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    This Post Has 23 Comments
    1. I did terrible this quiz but for Q1 (which I got wrong) I figure Reserves are part of the money supply and they can increase continually forever and not be inflationary, it is when they’re loaned out that they may have an inflationary impact.

    2. As usual I’m languishing in the ‘neo-liberal’ tendency…not deliberately you understand? Just that some of the questions are ‘effin difficult. I feel a bit hard done by given that getting just one more question right (I got three this time, my best ever) turns me from a neo liberal into an MMT foot soldier.

    3. I got caught on Q1 too.
      When I read it, I thought it was a slam dunk and picked True! Wrong!!

      More thought required. So, I put this together

      What have I learned? Where do I start? That would be: Inflation results when the amount of government spending exceeds the capacity of the real economy to produce the required goods & services.

      Back to reading “Who the cap fits?” carefully. Bill wrote and emphasized, “Mainstream macroeconomics, which Krugman is just repeating here, considers that the impacts of fiscal policy vary according to the way in which the government “funds” itself.” … (i.e. taxation; debt-issuance; or money creation). In addition, mainstream thought concludes that government spending resulting from money creation is more inflationary than debt-issuance.

      So, the answer is False because inflation results from too much spending, relative to economic capacity, not on its perceived source which is what is widely believed. And, I presume this was the instructive intent of the question. I didn’t and now I do.

    4. Regarding Q1

      The tricky word to me was “continually”, because it could be construed to mean “to an unlimited degree.” But the correct definition is “for an unlimited time,” and this changes the answer from true to false. If the economy grows continually, which it can be made to do, then the money supply can get bigger every year and never cause inflation.

      I think “money supply” means spendable money in private hands – demand deposits, bills and coins.

      GeRoMi – I think you are correct too. The threshold question is whether deficit spending is “always and everywhere” inflationary, as Milton Friedman and his Quantity-of-Money pals used to say.

    5. NeilT,

      Welcome to the club. I’ve been taking this quiz every week for over a year, and I have gotten all five correct exactly twice. And one of those required mere luck. At the beginning, my typical score was one or two. Now it’s three or four (including four right today). I don’t think I’ll get much better – Bill is too good at making them hard.

      The hardest regular question for me this time was Q3. I know that fighting inflation is not the reason for government borrowing from the private sector, but I had to think a while before deciding whether it is an unintended consequence. In the end, I decided that government bonds are so liquid they couldn’t possibly retard anyone’s spending decisions for more than an hour or so, and I got the question right. I’m not out of the woods though. It often happens that I get one right through faulty or irrelevant reasoning. I’m looking forward to the complete answer tomorrow.

      Cheers

    6. Dale

      Q3 was the only one I got right. However, I didn’t think I was just lucky.

      Upfront, I’m new to MMT thinking. When I found out the government didn’t need to use debt-issuance to spend (yes I was pretty uniformed), I wondered what the role of bonds were in the monetary system. What stuck was they were used by the CB to set interest rate targets (not to reduce demand) and that was the primary function of bonds in fiat currency system.

      Am I thinking too simplistically? Yes/No? Any additional thoughts?

    7. I’ve never got the maximum in 7 months of trying. The low point was a ‘zero point zero’
      I now seem to be getting consistent 4/5s which i think means I’ve lost most of my neo-liberal tendencies
      It helps to read the question 3 or 4 times. Bill can be quite sneaky.

    8. Senexx said: “I figure [central bank] Reserves are part of the money supply …”

      If “money supply” means the medium of exchange supply for goods/services and/or financial assets then no. I see central bank reserves as a type of medium of exchange ONLY within the banking system covered by the fed.

      And, “and they can increase continually forever and not be inflationary, it is when they’re loaned out that they may have an inflationary impact.”

      I don’t believe it is quite accurate to say central bank reserves are loaned out. If too many loans are made (bringing future demand to the present) relative to the amount of real goods/services available in the present, then price inflation can occur.

    9. GeRoMi said: “What have I learned? Where do I start? That would be: Inflation results when the amount of government spending exceeds the capacity of the real economy to produce the required goods & services.”

      How about price inflation results when the total amount (gov’t and non-gov’t) of spending exceeds the capacity of the real economy to produce the required goods & services?

      And, “In addition, mainstream thought concludes that government spending resulting from money creation is more inflationary than debt-issuance.”

      Should it be government (or even total) spending resulting from currency creation with no bond attached is more price inflationary IN THE FUTURE than debt-issuance but is the same IN THE PRESENT?

    10. Dale said: “I think “money supply” means spendable money in private hands – demand deposits, bills and coins.”

      I’d rather see people call that the medium of exchange supply, which means the amount of currency plus the amount of demand deposits like you said.

      And, “If the economy grows continually, which it can be made to do, then the money supply can get bigger every year and never cause inflation.”

      I like phrasing that like this. If positive productivity growth and cheap labor allow the amount of goods/services to expand each year, does the amount of medium of exchange need to increase each year so its value does not rise, so its velocity may not slow down, and so it may not be used as a risk free savings vehicle?

      The BIG point I like to make is: “Is there a difference between creating more medium of exchange from demand deposits with a bond attached and creating more medium of exchange from demand deposits/currency with no bond attached, especially when price inflation does not happen or is used to prevent price deflation?

    11. Dale said: “GeRoMi – I think you are correct too. The threshold question is whether deficit spending is “always and everywhere” inflationary, as Milton Friedman and his Quantity-of-Money pals used to say.”

      What happens if there is a negative aggregate supply shock?

    12. Dale said: “Bill is too good at making them hard”

      Andy said: “Bill can be quite sneaky.”

      I don’t really like that. I wish he would be more specific and/or emphasize certain words or phrases. For example, when he is talking about sectoral balance questions, he could capitalize PRIVATE and/or HOUSEHOLD along with CORPORATE (meaning the private sector can be made up of the household and corporate sectors).

    13. GeRoMi said: “Upfront, I’m new to MMT thinking. When I found out the government didn’t need to use debt-issuance to spend (yes I was pretty uniformed), I wondered what the role of bonds were in the monetary system. What stuck was they were used by the CB to set interest rate targets (not to reduce demand) and that was the primary function of bonds in fiat currency system.

      Am I thinking too simplistically? Yes/No? Any additional thoughts?”

      Can setting an interest rate target be an attempt to reduce demand?

      Can gov’t bonds with an assumed zero default risk be used as collateral to make new loans?

    14. Fed Up writes

      1. “How about price inflation results when the total amount (gov’t and non-gov’t) of spending exceeds the capacity of the real economy to produce the required goods & services?” I get it. Too much aggregate demand (product of total public & private spending) is inflationary.

      2. “Should it be government (or even total) spending resulting from currency creation with no bond attached is more price inflationary IN THE FUTURE than debt-issuance but is the same IN THE PRESENT?” I chose my initial wording to keep it really simple and hopefully correct. I just started to realize effects over time are important. Had never thought about the time effect differences between bonds and loans i.e. bonds delay spending to some future date and loans bring future earnings into the present. Again one of those obvious observations. Food for thought.

      3. “Can setting an interest rate target be an attempt to reduce demand?” Now that you ask. I do believe your correct. Everybody expects Bernanke to raise interest rates once the economy picks up to reduce demand if necessary.

      4. “Can gov’t bonds with an assumed zero default risk be used as collateral to make new loans?” Never tried but I’m assuming the bank would accept them as collateral to secure a personal loan. In this case use of an existing bond would increase demand.

      Thanks for considering my stuff. I’m in that willing to learn new stuff mode.

      P.S. If you don’t mind me asking, where does your handle Fed Up come from?

    15. Fed Up:I don’t really like that. I wish he would be more specific and/or emphasize certain words or phrases.

      That’s why I only take the quizz when I had nothing better to do. It’s an exercise of reading skills rather than economics.

      Moreover, I believe saying the answer to question 3 is False is miseducating as much as saying it is True.

    16. Mammoth, I disagree
      The point is surely to get people to think. There more inexact the question and the more the wording of it infuriates then surely the more people will actually examine the issue. I know I do.

    17. 8 or 9 months for me…one full score a few below that but generally 2-3, lately got tripped up on the private/household/corporate so hopefully I wont do that again!

      It’s always important to question what the question is, something I don’t always give enough time to I suppose.

      Online and offline people do tend to jump to conclusions based on their own views/prejudices/perceptions/brainwashing and let’s face it we’re all ‘influenced’/’brainwashed’ what matters is how aware of our own worldview/value-grid we are.

    18. GeRoMi said: “I just started to realize effects over time are important. Had never thought about the time effect differences between bonds and loans i.e. bonds delay spending to some future date and loans bring future earnings into the present. Again one of those obvious observations. Food for thought.”

      IMO, most of the current economic problems arise from the time differences between spending and earning that debt allows along with wealth/income inequality.

      And, “Can gov’t bonds with an assumed zero default risk be used as collateral to make new loans?” Never tried but I’m assuming the bank would accept them as collateral to secure a personal loan. In this case use of an existing bond would increase demand.”

      I suppose that is possible, but I’m not sure how often it occurs. I was thinking more about investment banks, hedge funds, and/or the repo market.

      And, “P.S. If you don’t mind me asking, where does your handle Fed Up come from?”

      I’m fed up with the fed, almost all bankers, almost all politicians, and almost all economists and anyone who thinks the solution to too much debt is more debt.

    19. MamMoTh said: “Moreover, I believe saying the answer to question 3 is False is miseducating as much as saying it is True.”

      It seems to me that “By draining funds out of the system,” is not specific enough or open to too much interpretation.

    20. Senexx said: “Fed Up, Yep.

      I didn’t and never tend to separate the monetary base from the money supply as it can all become currency / physical money”

      But since TCMDO at the St. Louis FRED (from the fed’s flow of funds) is about 52 trillion (maybe about 58 trillion counting what the gov’t “owes itself”) and the monetary base is about 2.5 trillion (???), is it possible that there is a lot of time difference(s) between spending and earning that has build up over time?

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