ECN 600 – Under which the federal budget was required to be balanced during every fiscal year

1. Suppose a budget-balance amendment was
passed, under which the federal budget was required to be balanced during every
fiscal year. Discuss potential implications of this amendment on business-cycle
activity.
2. Recall the steady state debt-to-GDP
ratio derived in the text:pd++= Y n g D
. Show the expression for the law of motion for D, provide the intuition behind
the result that a larger inflation ratep enables
a smaller steady state ratio.
3. Consider again the relationship between
the inflation ratep and the debt-to-GDP ratio D/Y. As noted in the text, as this ratio
increases, the greater is the risk of inflation. Why is this so? And what
accounts for the difference in relationships between D/Y andp here and
in exercise 2? (25 marks)
4. If the government’s share of GDP in
spending shrinks over the next generation, what in your view is likely to
happen to the size of the business cycle? (25 marks)
5. Explain which business cycle theory subscribes
to each one of the following
(a) Workers are worried about their
position relative to other workers, and do not accept wage cuts in recessions.
b) Recessions force relatively unproductive
firms out of the economy.
c) Business cycles are caused by misguided
government policies.
d) Business cycles are driven by changes in
productivity.
e) Business cycles are driven by
fluctuations in the expectations of the entrepreneurs regarding the future
levels of business activities.
f) Business cycles are driven by changes in
aggregate demand, which are, in turn, caused by fluctuations in government
spending.
g) Governments should intervene to
stabilize recessions, otherwise the economy will head into even more severe
recessions.

6. Consider a small
open economy with a fixed exchange rate system. Suppose there is a general
expectation that the central bank will revalue the domestic currency (i.e.,
that it will reduce e ) in the future. Explain the short run effects of this on
the economy.

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