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Saturday Quiz – August 29, 2009

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

1. The problem in the baby-sitting economy was that the cooperative were running a budget surplus which constrained the number of scrips that were available to exchange for baby-sitting services.

2. If private investors become saturated with Australian government debt issues as the deficits rise, their demand will drop and yields will rise for those maturities (say 10-year bonds). This spills over into increased borrowing costs for the private sector generally and reduces the desire to invest.

3. A country that has been running budget surpluses will have less capacity to deal with an economic downturn, despite what mainstream economists say. This is because to maintain spending growth in the face of rising fiscal drag, the private sector would have built up higher levels of debt than otherwise and face increased insolvency risk as a consequence.

4. The massive build-up of Chinese holdings of US government debt has allowed US citizens to enjoy a higher material standard of living at the expense of the residents of China.

5. Short-term interest rates are set by the central bank while the fiscal strategy manifests in tax and spending decisions by the government. Whereas the private sector cannot directly influence the interest rate target being set it can determine the size of the budget deficit at any point in time.

6. The US Federal Reserve is about to take over the New York Times and use its printing press to print more government bonds.

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    This Post Has 4 Comments
    1. I have an elementary question regarding (2), which will probably see me sent to the back of the class, but here goes anyway..

      I don’t believe that additional debt issuance would necessarily reduce demand for it, but I would have thought that, all else equal, an increasing supply of government debt would tend to lower the price of newly issued debt, causing yields to rise. Or is this a case where the extra supply generates extra demand, offsetting such a price effect?

      I understand that the funds (and hence potential demand) to pay for the newly issued debt come from government spending in the first place, and that there is no crowding out effect, but I can’t seem to get my head around this seemingly fundamental issue.

      Feeling pretty stupid, can anybody help?

    2. Dear ParadigmShift

      Whether the demand for public debt falls as more debt is issued is not the question. That may or may not occur depending on the circumstances. But if we take it as given that the private demand falls then under the auction systems in place yields rise to clear the tender. So that part is true (by definition). But the second part is clearly false but it is the inference that is usually made by those who claim that public borrowing forces up borrowing costs generally.

      Don’t feel stupid.

      best wishes

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