Saturday Quiz – April 28, 2012

1. Assume that the national accounts of a nation is reveal that its external surplus is equivalent to 2 per cent of GDP and the private domestic sector is saving overall 3 per cent of GDP. We would also observe:

2. Given a fiat currency issuing nation is not revenue constrained, it is incorrect to say that recipients of income support provided by such a national government are living off the hard work of those who pay income taxes.

3. The British government's budget deficit rose in March 2012. We can conclude from that result that it is still pursuing an expansionary fiscal policy despite the political rhetoric about austerity.

4. There is no difference in terms of the impact on aggregate demand, between the government matching its deficit spending with bond issues and the situation where the government instructed the central bank to buy its bonds to match the deficit.

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 2 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 2 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 4 per cent. In Year 2, the government stimulates the economy and pushes the primary budget deficit out to 4 per cent of GDP in recognition of the severity of the recession. In doing so it stimulates aggregate demand and the economy records a 4 per cent nominal GDP growth rate. The central bank holds the nominal interest rate constant but inflation falls to 1 per cent given the slack nature of the economy the previous year. Under these circumstances, the public debt ratio falls even though the budget deficit has risen because of the real growth in the economy.