Question 3 - Government finances and deficit bias (20 points) The percent change in the government debt ratio is given by: DG-T + iD D y = Assume that country A has a fiscal deficit (primary deficit plus interest payments) as a share of GDP of 4%, an inflation rate of 2%, a real growth rate of 2% and an initial debt ratio of 50%. - (+9) y Country B also has a debt ratio of 50%, but a fiscal deficit of 6% of GDP. The growth rate of country B is 4% and the inflation rate is 6%. a) Calculate the change in the debt ratio for countries A and B. respectively. (4 points) b) What fiscal deficit must country A and country B have to achieve stable government finances, respectively (i.e. 4) = 0)? (4 points) c) Assume that the fiscal deficit, inflation rate and real growth rate remain at their initial levels, what debt ratio will country A and country B reach in the long run (1.e. when. 4 = 0)? (4 points) d) Based on your previous results, which country do you think is closest to having its government finances under control. Motivate your answer. (4 points) e) The coronavirus pandemic has led to increased government spending and decreased tax revenue in many countries. Based on the previous debt ratio equation, how will this affect a country's debt level? In your view, is a short-run increase in government debt motivated? (4 points) Question 3 - Government finances and deficit bias (20 points) The percent change in the government debt ratio is given by: DG-T + iD D y = Assume that country A has a fiscal deficit (primary deficit plus interest payments) as a share of GDP of 4%, an inflation rate of 2%, a real growth rate of 2% and an initial debt ratio of 50%. - (+9) y Country B also has a debt ratio of 50%, but a fiscal deficit of 6% of GDP. The growth rate of country B is 4% and the inflation rate is 6%. a) Calculate the change in the debt ratio for countries A and B. respectively. (4 points) b) What fiscal deficit must country A and country B have to achieve stable government finances, respectively (i.e. 4) = 0)? (4 points) c) Assume that the fiscal deficit, inflation rate and real growth rate remain at their initial levels, what debt ratio will country A and country B reach in the long run (1.e. when. 4 = 0)? (4 points) d) Based on your previous results, which country do you think is closest to having its government finances under control. Motivate your answer. (4 points) e) The coronavirus pandemic has led to increased government spending and decreased tax revenue in many countries. Based on the previous debt ratio equation, how will this affect a country's debt level? In your view, is a short-run increase in government debt motivated? (4 points)