1. Economists use two multipliers to estimate the impact on GDP of an expansion in government spending associated with rising tax rates. The spending multiplier indicates the extent to which GDP rises as a result of the extra aggregate demand arising from the increased government spending. The tax multiplier indicates the impact of rising tax rates on GDP as labour supply is reduced because of the disincentives associated with taxation. The net effect on GDP is the sum of these two impacts.

Answer: False

2. EMU member nations face solvency risk because they do not issue their own currency. This source of risk would not be eliminated if these nations exited the Eurozone and re-established their currency sovereignty - that is, issued their own floating currency.

Answer: True

3. For a nation running a current account deficit, national income adjustments will ensure government budget is in deficit no matter what the government's intentions are if the private domestic sector is spending less than its income.

Answer: True

4. It would be impossible for a government to avoid issuing debt to the private sector when running a budget deficit while the central bank was targeting a positive short-term policy rate.

Answer: False

5. Premium question: Assume that the government increases spending by $100 billion at the start of each year and maintains this policy for the next three years from now. Economists estimate the spending multiplier to be 1.5 and the impact is exhausted within each year (all induced consumption is completed within 12 months). The tax multiplier is estimated to be equal to 1 and the current tax rate is equal to 30 per cent (so tax revenue rises by 30 cents for every extra dollar of GDP produced ). What is the cumulative impact of this fiscal expansion on GDP after three years?

Answer: $450 billion