1. Consider an economy characterized by the following facts: i. The official deficit is 4% of GDP. ii. The debt-to-GDP ratio is 100%. iii. The nominal interest rate is 10%. iv. The inflation rate is 7%

a. What is the primary deficit/surplus ratio to GDP? b. What is the inflation-adjusted deficit/surplus ratio to GDP?

For this economy a reliable rule-of-thumb is that a 1% decrease in output leads automatically to an increase in the deficit of about 0.5% of GDP.

c. Suppose that output is 2% below its natural level. What is the cyclically adjusted, inflation-adjusted deficit/surplus ratio to GDP? d. Suppose instead that output begins at its natural level and that output growth remains constant at the normal rate of 2%. What will be the debt-to-GDP ratio: after 1 year, after 2 years, after 10 years? (Assume primary surplus stays the same for all years)