Saturday Quiz – July 30, 2011

1. For the US private sector to reduce its overall overall debt levels, the government must run a deficit.

2. Larger fiscal deficits as a percentage of GDP reduce the local productive resources that are available to the private sector.

3. A national government that issues its own currency and freely floats it on foreign markets never faces a risk of insolvency.

4. The US Federal Reserve could easily directly purchase Treasury debt to facilitate the US Government’s budget deficit without compromising its monetary policy settings because its short-term policy rate is already near zero.

5. Premium Question: Assume the government increases spending by $100 billion from now and maintains that injection for three years. Economists estimate the spending multiplier to be 1.6 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) and the current tax rate is equal to 20 per cent. They also estimate that the tax multiplier (impact of tax changes on income) to be equal to 1. Which of the following statements is correct?