{"id":39243,"date":"2018-05-05T16:00:02","date_gmt":"2018-05-05T06:00:02","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=39243"},"modified":"2018-05-05T16:00:02","modified_gmt":"2018-05-05T06:00:02","slug":"the-weekend-quiz-may-5-6-2018-answers-and-discussion","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=39243","title":{"rendered":"The Weekend Quiz – May 5-6, 2018 – answers and discussion"},"content":{"rendered":"

\t\t\t\tHere are the answers with discussion for this Weekend’s Quiz<\/strong>. The information provided should help you work out why you missed a question or three! If you haven’t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of modern monetary theory (MMT) and its application to macroeconomic thinking. Comments as usual welcome, especially if I have made an error.
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\nQuestion 1:<\/strong><\/p>\n

\nOver a given economic cycle (peak to peak), if a nation’s external sector is on average balanced and the government gap between its tax revenue and spending is, on average, equal to 1 per cent of GDP, then the private domestic sector’s spending-income balance will on average be in:<\/p>\n

(a) Deficit of 1 per cent of GDP<\/p>\n

(b) Surplus of 1 per cent of GDP\n<\/p><\/blockquote>\n

The answer is Deficit of 1 per cent of GDP<\/strong>.<\/p>\n

This is a question about sectoral balances. Skip the derivation if you are familiar with the framework.<\/p>\n

To refresh your memory the balances are derived as follows. The basic income-expenditure model in macroeconomics can be viewed in (at least) two ways: (a) from the perspective of the sources<\/strong> of spending; and (b) from the perspective of the uses<\/strong> of the income produced. Bringing these two perspectives (of the same thing) together generates the sectoral balances.<\/p>\n

From the sources<\/strong> perspective we write:<\/p>\n

(1) GDP = C + I + G + (X – M)<\/p>\n

which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X – M).<\/p>\n

Expression (1) tells us that total income in the economy per period will be exactly equal to total spending from all sources of expenditure.<\/p>\n

We also have to acknowledge that financial balances of the sectors are impacted by net government taxes (T) which includes all tax revenue minus total transfer and interest payments (the latter are not counted independently in the expenditure Expression (1)).<\/p>\n

Further, as noted above the trade account is only one aspect of the financial flows between the domestic economy and the external sector. we have to include net external income flows (FNI).<\/p>\n

Adding in the net external income flows (FNI) to Expression (2) for GDP we get the familiar gross national product or gross national income measure (GNP):<\/p>\n

(2) GNP = C + I + G + (X – M) + FNI<\/p>\n

To render this approach into the sectoral balances form, we subtract total net taxes (T) from both sides of Expression (3) to get:<\/p>\n

(3) GNP – T = C + I + G + (X – M) + FNI – T<\/p>\n

Now we can collect the terms by arranging them according to the three sectoral balances:<\/p>\n

(4) (GNP – C – T) – I = (G – T) + (X – M + FNI)<\/p>\n

The the terms in Expression (4) are relatively easy to understand now.<\/p>\n

The term (GNP – C – T) represents total income less the amount consumed less the amount paid to government in taxes (taking into account transfers coming the other way). In other words, it represents private domestic saving.<\/p>\n

The left-hand side of Equation (4), (GNP – C – T) – I, thus is the overall saving of the private domestic sector, which is distinct from total household saving denoted by the term (GNP – C – T).<\/p>\n

In other words, the left-hand side of Equation (4) is the private domestic financial balance and if it is positive then the sector is spending less than its total income and if it is negative the sector is spending more than it total income.<\/p>\n

The term (G – T) is the government financial balance and is in deficit if government spending (G) is greater than government tax revenue minus transfers (T), and in surplus if the balance is negative.<\/p>\n

Finally, the other right-hand side term (X – M + FNI) is the external financial balance, commonly known as the current account balance (CAD). It is in surplus if positive and deficit if negative.<\/p>\n

In English we could say that:<\/p>\n

The private financial balance equals the sum of the government financial balance plus the current account balance.<\/p>\n

We can re-write Expression (6) in this way to get the sectoral balances equation:<\/p>\n

(5) (S – I) = (G – T) + CAD<\/p>\n

which is interpreted as meaning that government sector deficits (G – T > 0) and current account surpluses (CAD > 0) generate national income and net financial assets for the private domestic sector.<\/p>\n

Conversely, government surpluses (G – T < 0) and current account deficits (CAD < 0) reduce national income and undermine the capacity of the private domestic sector to add financial assets.<\/p>\n

Expression (5) can also be written as:<\/p>\n

(6) [(S – I) – CAD] = (G – T)<\/p>\n

where the term on the left-hand side [(S – I) – CAD] is the non-government sector financial balance and is of equal and opposite sign to the government financial balance.<\/p>\n

This is the familiar MMT statement that a government sector deficit (surplus) is equal dollar-for-dollar to the non-government sector surplus (deficit).<\/p>\n

The sectoral balances equation says that total private savings (S) minus private investment (I) has to equal the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)) plus net income transfers.<\/p>\n

All these relationships (equations) hold as a matter of accounting and not matters of opinion.<\/p>\n

Consider the following graph which shows three situations where the external sector is in balance.<\/p>\n

Period 1, is the case in point with the fiscal position in surplus (T – G = 1) and the private balance is in deficit (S – I = -1). With the external balance equal to 0, the general rule that the government surplus (deficit) equals the non-government deficit (surplus) applies to the government and the private domestic sector. In other words, the private domestic sector must be spending ore than it is earning (a deficit).<\/p>\n

In Period 3, the fiscal position is in deficit (T – G = -1) and this provides some demand stimulus in the absence of any impact from the external sector, which allows the private domestic sector to save (S – I = 1).<\/p>\n

Period 2, the fiscal position is in balance (T – G = 0) and so the private domestic sector must also be in balance (spending equals its earning).<\/p>\n

The movements in income associated with the spending and revenue patterns will ensure these balances arise. The problem is that if the private domestic sector desires to save overall<\/strong> then this outcome will be unstable and would lead to changes in the other balances as national income changed in response to the decline in private spending.<\/p>\n

\"\"<\/a><\/p>\n

<\/div>\n

So under the conditions specified in the question, the private domestic sector cannot save. The government would be undermining any desire to save by not providing the fiscal stimulus necessary to increase national output and income so that private households\/firms could save. <\/p>\n

You may wish to read the following blogs for more information:<\/p>\n