XYZ is a country that is deeply in debt as the government continues to borrow both internally and externally. Health care, education, and housing are heavily subsidized by the government. However, because of the governments heavy borrowing and over dependence on deficit financing and non-market based interventions, the levels of both domestic and external debts have ballooned and become unsustainable- a condition referred to as twin deficits and dual gaps. There is internal and external imbalance or disequilibrium in the Budget and Balance of Payments respectively. The Secretary to the Treasury has suggested to the Northland Cabinet that the way out of the imbroglio, morass, and quagmire was to impose heavy direct and indirect taxes on incomes, goods and services to free space in the budget or to resort to

Quantitative Easing or printing more money to gain seignior age. Others have suggested resorting to Mezzanine financing by using both borrowing from non-concessionary loans

and issuing shares and government bonds. Members of the Economic Advisory Council (EAC) think-tank which is chaired by Prof.Amenshi Mpia have differed with the Secretary to the Treasury as they have argued that tax is inflationary and also a deflator of economic growth. They had advised the government to borrow from both concessionary and non-cessionary lenders so that the tax burden can be deferred to a future generation which critics say is immoral as it creates inter-generational debt. The National Liberal Lobby (NLL) thinks the best way out of the dilemma is to do none of the two but rather resort to fiscal discipline, reducing government expenditure, fighting corruption, decentralizing government functions, and privatizing all national enterprises by offloading them to the private sector for sale. Their arguments follow those recommended by the Washington Consensus of the World Bank and IMF. The NLL buttress their arguments by referring to the Laffer Curve, the Lorenz Curve, and the J-Curve .The J-Curve states that a change should make things worse at first before it gets better later. Already in Northland, the external rating agents of Fitch, Moody, and Standard & Poor (S&P) have downgraded Northlands grading from C to C which makes her high risk and creditworthiness questionable to lenders. It is feared that excessive government borrowing has led to crowding out effect on the private sector, creating an elephant in the room, as it were with noelbow space or room to swing a cat. The Opposition Party in the country, The People Opposing Party (POP), has called on the ruling party to declare a state of emergency.

1. Explain the following:
2. Laffer Curve, (3mk)
3. Lorenz Curve (3mk)
4. J-Curve. (3mk)

(b) Critically examine each of the arguments put forward by the NLL in this case Study(6mk)

(c) Analyze the case for and against imposing excessive taxes or borrowing heavily (6mk)

Q2

When governments run budget deficits over a long period of time, they create unsustainable public debt through their internal and external borrowing.

Critically evaluate the impact of public debt on the economic performance of a country (9mks)