Quiz #109 answers

• 1. Even Modern Monetary Theory accepts that continually expanding the money supply will inevitably be inflationary.

Answer: False

• 2. If there is an external deficit of 2 per cent of GDP and the government balances its budget then the private sector will have:

Answer: an excess of spending relative to its income equal to 2 per cent of GDP.

• 3. By draining funds out of the system, government borrowing from the private sector reduces the risk that public spending will overheat the economy.

Answer: False

• 4. A national government would be unable to rely on the central bank purchasing treasury debt to match its budget deficit (that is, "monetise the deficit") if the central bank is targeting a positive short-term policy rate.

Answer: False

• 5. Premium Question - In Year 1, the economy plunges into recession with nominal GDP growth falling to minus -1 per cent. The inflation rate is subdued at 1 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 1 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 3 per cent. In Year 2, the government stimulates the economy and pushes the primary budget deficit out to 2 per cent of GDP and in doing so stimulates aggregate demand and the economy records a 4 per cent nominal GDP growth rate. All other parameters are unchanged in Year 2. Under these circumstances, the public debt ratio:

Answer: none of the above.