Seminar 4: Economic policy and the open economy

Question 2

Question 2 A heavily indebted government may end up in a vicious circle, where higher interest rates and lower growth exacerbate the debt burden. a. Derive an expression for how the change in the government debt-to-GDP ratio depends upon the primary deficit (relative to GDP), the earlier debt-to-GDP ratio, the interest rate and the GDP growth rate. b. By how much will the government debt ratio increase in a year if the outstanding debt is 100 per cent of GDP, the primary deficit 10 per cent of GDP, the interest rate 2 per cent and the GDP growth rate 1 per cent? What primary fiscal balance is required to stabilise debt? c. Consider a country similar to Greece in 2013. Assume that the existing debt is 160 per cent of GDP, the primary deficit 3 per cent of GDP, the interest rate 10 per cent and the GDP growth rate -4 per cent. Compute the annual growth in the debt-ratio in this economy. What primary fiscal balance is required to stabilise debt?Question 3 Following the setting discussed in Lecture 8, suppose that net exports, NXt, are determined by the following expression: NX =ONX - BNX (T - r;), (6) where Y, is potential GDP and r, - r* is the difference between the domestic and the foreign real interest rate. a. Explain the intution behind expression (6). b. Modify the IS curve from Lecture 5 so that (6) is taken into account. c. Explain how an increase in the domestic real interest rate affects short-run output in this economy.Question 4 According to the Balassa-Samuelson effect, price levels are related to productivity in the trad- ables sector. a. Explain the intuition behind the Balassa-Samuelson effect. b. What does the Balassa-Samuelson effect imply for differences in price levels between rich and poor countries? c. What does the Balassa-Samuelson effect imply for differences in inflation between rich and poor countries