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Saturday Quiz – December 5, 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. Central banks (for example, US Federal Reserve, Reserve Bank of Australia, and the Central Bank of Ireland) conduct monetary policy by setting the short-run interest rate rather than trying to control the money supply which is endogenous.

2. An economist who believed in Ricardian Equivalence would argue that the boost of retail sales in Australia following the December stimulus package had nothing to do with the $900 cash handout. Households would have merely saved the handout to pay for future tax rises.

3. When the German constitutional requirement that the federal budget be balanced at all times comes into force, fiscal policy will become pro-cyclical and destabilising.

4. The reason estimates of structural budget deficits are to be treated with suspicion relates to the fact that typically the implicit estimates of potential GDP are too optimistic.

5. The introduction of an employment guarantee where the federal government offers a minimum wage job to anyone who wanted one would require a modest increase in the budget deficit but there would never be a question that a sovereign government could not afford this program.

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    This Post Has 2 Comments
    1. Hi Bill,


      > Central banks (for example, US Federal Reserve, Reserve Bank of Australia, and the Central Bank of Ireland) conduct monetary policy by setting the short-run interest rate rather than trying to control the money supply which is endogenous.

      Let me please ask you again : is Ireland (and each member of the Eurozone) revenue constrained, or not? I’m not talking about the 3% (soft) upper bound on deficits, but the ability to credit bank accounts by decree, which translates into net financial assets. As per

      I have a feeling the answer is no. BTW, the above rules were already in effect in some countries before the Euro.

      In Deficits 101 you referenced which states that the RB “provides a facility to the Australian Government that is used to manage a group of bank accounts, the aggregate balance of which represents the Government’s daily cash position.”.

      I guess facility here is to be understood as an overdraft facility, the one by which the government credit bank accounts, and the amount of which equals “net spending”. Furthermore,

      “These banking arrangements include the provision of a term-deposit facility for the investment of surplus funds, the sweeping of balances to and from agencies’ accounts held with transactional bankers, and access to a strictly limited overdraft facility.”

      Is “limited overdraft facility” consequential or unrelated to the proposition that governments are not revenue constrained?

    2. BX12,
      Ireland, as a member of the euro zone, is revenue constrained. Government spending is financed through the issue of currency, taxes generate demand for that currency that results in sales to government, bond sales merely substitute bonds for cash, and central bank operations determine interest rates and defensively add or subtract reserves. The relation of member countries to the European Monetary Union (EMU) is more similar to the relation of the treasuries of member states of the United States to the Fed than it is of the US Treasury to the Fed. In the US, states have no power to create currency; in this circumstance, taxes really do ‘finance’ state spending and states really do have to borrow (sell bonds to the markets) in order to spend in excess of tax receipts. Purchasers of state bonds do worry about the creditworthiness of states, and the ability of American states to run deficits depends at least in part on the perception of creditworthiness. While it is certainly true that an individual state can always fall back on US government help when required (although the recent experience of California makes that assumption less secure), it is not so clear that the individual countries in the euro zone are as fortunate. Functionally, each nation state operates the way individual American states do, but with ONLY individual state treasuries.

      The euro dilemma is somewhat akin to the Latin American dilemma, such as countries like Argentina regularly experienced. Deficit spending in effect requires borrowing in a “foreign currency”, according to the dictates of private markets and the nation states are externally constrained. That’s why Iceland and Latvia are in a mess and suffer from solvency issues. It’s also why California suffers from a solvency issue or Italy or Spain. Not the US or Japan.

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