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(b) has to be attained, as determined by a formula such as:

b = (i - g) k

(c) When the debt is not consolidated, future interest payments place pressure on the ability of the government to meet its liabilities.  Interest rates will rise, worsening further the financial position of the state and depressing private expenditure.  Such a situation creates economic and political instability.

(d) A stable macroeconomic environment helps to ensure the efficient working of the market system (see also Chapter 12).  In such a stable environment, and with the help of market-friendly policies in the capital and labour markets, business investment will increase and growth and employment will be attained.

(e) An easing of monetary policy means lowering interest rates and allowing faster monetary growth.  Monetary stability means that money supply expands to accommodate money demand in line with real growth of output plus allowing for up to 2% inflation.  

(f)  Actual GDP must be below potential GDP; if this is not the case, inflation arises because the economy already has full utilisation of capacity.  Also one would like to be assured that there is no evidence of actual or incipient cost inflation in the economy.

Q3 Would an average, well-run business agree to limit itself to a zero borrowing target over the business cycle? Why do some business lobbies urge governments to constrain government spending according to this rule? Is this a sensible rule for governments to adopt?

Business operators are concerned about the effects of fiscal policy on the private sector. From their point of view, zero borrowing means low interest rates and low taxes which are positive for them.

Yet, a well-run average business hardly limits itself to a zero borrowing. The firm borrows money to finance its productive activities.  But the amount borrowed is limited: otherwise interest repayments would exceed profits, and the company would go bankrupt.  State borrowing is not subject to any such automatic market discipline and that is why it must be subjected to special scrutiny.  If the state borrows from the private sector, this borrowing should be monitored so that the debt : GDP ratio could be maintained over the business cycle to a certain threshold which is considered sustainable.

Q4  A country has a debt ratio of 130% of GNP, it pays 10% interest on this debt and its nominal growth rate is 7%. What primary balance (as per cent of GNP) should it be targeting if it wants to stabilise the debt ratio? You are told that its total deficit is currently running at 9% of GNP. Does this country have a fiscal problem?

Another country has a debt ratio of 40%, it pays 7% interest and its nominal GNP is growing at 6% annually. Its present total budget deficit : GNP ratio is 1.7%. Is this country's debt ratio growing or declining?


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