Saturday Quiz – July 27, 2013

1. The data shows that the private domestic sector in a nation with a very small external deficit (as a % of GDP) is spending less than it earns. However, you cannot tell what the government budget balance will be as a percentage of GDP until you know whether the external balance offsets the private domestic balance.

2. Modern Monetary Theory (MMT) observes that the private sector is wealthier if a currency-issuing government matches its deficit spending with bond issues relative to a situation where the government maintained the same size deficits without issuing bonds to the private sector.

3. 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 introduces a fiscal stimulus and pushes the primary budget deficit out to 3 per cent of GDP to head of a recession. In doing so it stimulates aggregate demand and nominal GDP growth rises to 4 per cent nominal GDP growth rate. The central bank holds the nominal interest rate constant and inflation is stable. In Year 3, there is no change in monetary policy, and the government expands fiscal policy by an additional 1 per cent of GDP. Inflation is stable and nominal GDP growth rises to 6 per cent. From this data, you can conclude that: