1. Start from a situation where the external surplus is the equivalent of 2 per cent of GDP and the budget surplus is 2 per cent. If the budget balance stays constant and the external surplus rises to the equivalent of 4 per cent of GDP then:

National income falls and the private surplus moves from 0 per cent of GDP to 2 per cent of GDP.
National income remains unchanged and the private surplus moves from 0 per cent of GDP to 2 per cent of GDP.
National income rises and the private surplus moves from 0 per cent of GDP to 2 per cent of GDP.
National income falls and the private surplus moves from 4 per cent of GDP to 6 per cent of GDP.
National income remains unchanged and the private surplus moves from 4 per cent of GDP to 6 per cent of GDP.
National income rises and the private surplus moves from 4 per cent of GDP to 6 per cent of GDP.

2. A rising budget deficit indicates that discretionary fiscal policy is expansionary.

3. Matching government deficit spending with bond issues is less expansionary than if the government instructed the central bank to buy its bonds to match the deficit.

4. If private households and firms decide to lift their saving ratio the national government has to increase its net spending (deficit) to fill the spending gap or else economic activity will slow down.

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