An economic quiz!

Let’s see if you have taken on board some of the things I’ve been writing about recently.

In a way,  life is simple for us currency users. We have to spend less than our income or we’ll end up in trouble eventually. We’ve all had experience of being a user but we can only imagine what it is like to be an issuer.

Let’s try to do just that. We’re the government and we have to issue currency by spending  and tax to get some of that currency back

1) Lets start off with an economy with little unemployment and low inflation. Its working as close to full capacity as is possible. The economy exports and imports in exactly equal amounts. The companies and individuals in the economy save and de-save (withdraw their savings) in exactly equal amounts too.
What is the correct course of action for government? Is it to aim to run:
A= A Balanced Budget    B= A  substiancial deficit    C= A substantial Surplus

2) Suppose a healthy industry grows up and the country starts exporting more than it imports. Say its 7% of GDP more. Money flows in as exports are paid for from overseas. The private sector still save and de-save in equal amounts. The industry owners successfully lobby the government to not let the currency rise. They don’t want their export prices to rise.
Now what is the correct course of action for government?

A, B, or C ?
Do we need to do anything else?

3) Industry owners and individuals in the economy decide , for whatever reason, that they would like to save more. Maybe individuals are getting older and need to put money aside for their retirement. They start to net save at the rate of 7% of GDP. The external surplus is still 7%

Now what is the correct course of action for government?
A, B, or C ?
Do we need to do anything else?

4) The country’s industry is overtaken by foreign competition. The external surplus disappears. It is back to an exactly even situation. Imports = Exports. Companies and individuals continue to net save at the rate of 7%. The government resolve to keep the currency stable.
What is our correct course of action?
A, B, or C ?
Do we need to do anything else?

5) Things get worse! (From a neoliberal perspective). The external situation turns into a 3% deficit. Individual and companies now net save less. Down to 4%
The government, ( that’s us!) still resolve to keep the currency stable.
What is our correct course of action?
A, B, or C ?
Do we need to do anything else?

A supplementary question.

6) What happens when governments, as they do,  choose the wrong answer?

The answers are in a comment below! You are welcome to comment too if you disagree.

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4 responses to “An economic quiz!

  1. 1) ‘A’. Balanced Budget. If we run a deficit we’ll risk inflation. If we run a surplus we’ll take money from the economy and run it into recession.

    2) ‘C’ The government needs to run a surplus. This removes the excess liquidity from the economy. The government uses the proceeds of that surplus to purchase treasury security bonds from its trading partners which are in deficit. This keeps the currency from rising and the currency of the deficit country falling. It effectively lends them back their money so they can carry on being good customers!

    3) ‘A’ Back to a balanced budget. The saving by the private sector has removed the excess liquidity. The government needs to supervise the process of the private sector buying the bonds from trading partners in deficit. This is pretty much Germany’s position right now.

    4) ‘B’ The Government need to run a 7% deficit to accommodate the desire of the private sector to net save. It effectively borrows its savings, by issuing bonds to commercial banks in exchange for the cash, and recycles it back into the economy via deficit spending.

    5) ‘B’ Again a 7% deficit is needed. 3% of which is to cover the external deficit. 4% of which is to cover the desire of the private sector to net save. Treasury securities are sold to trading partners which are in surplus and to commercial banks which hold the accounts of the savers. This is pretty much the UK’s position right now.

    6) If a Governments chooses to run a balanced budget when it should be running a surplus it will end up with high inflation. If it does that when it should be running a deficit then a recession and high unemployment will result.

    In every economy there are automatic stabilisers at work which will try to prevent this happening. So for example if the economy requires the government to run a surplus, and it cuts taxes, that will boost the economy and lead to even greater tax revenue and the surplus still remains.

    Conversely if it cuts spending and raise taxes to try to achieve a balanced budget revenue will fall and the deficit remains.

    However, if the Government is brutal enough in its actions it can overcome the stabilisers and seriously crash the economy!

  2. Yep, all 6 right! Except I wasn’t sure what you meant by “do we need to do anything else” until I’d taken a quick peek at one of your answers.

    They are a lot easier than Bill Mitchell’s quiz questions. Have you tried them?

    However, highly paid economists and politicians still don’t get it. That is very strange.

    Good to see an MMTer suggest that at times (your question 2) it is necessary for a government to run a budget surplus. MMT is not simply about running a huge deficit just for the sake of it under all circumstances

  3. Pingback: Why Governments Can’t Choose to Run Balanced Budgets. | Modern Monetary Theory: Real Economics

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