The Weekend Quiz – April 22-23, 2017

1. Assume that the national accounts of a nation 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. The fact that the Portuguese government's fiscal balance has fallen from 4.2 per cent in 2015 to 2.1 per cent in 2016 allows us to conclude that it was seeking to decrease the size of government in the overall economic output.

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 fiscal 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 fiscal 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 fiscal deficit has risen because of the real growth in the economy.