Consider the government of a two-period small open economy where t = 1,2. Interest rates in...

 

 

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Consider the government of a two-period small open economy where t = 1,2. Interest rates in the economy are given by ro= r₁=0.1. The government owns an initial level of government bonds B = -5. (a) Suppose that in period 1 the government spends G₁ = 10.5 and raises taxes for T₁ = 5. Compute the primary and secondary fiscal deficits of this government. Why do primary and secondary fiscal deficits differ? Does this country have to borrow in period 1? (b) In period 2, the government chooses G₂ = 11. What do taxes have to be in period 2, T2, in order for these levels of government expenditure to be sustainable? Compute the primary and secondary fiscal deficits of this country in period 2. (c) Suppose now that this government decides to lower taxes in period 1 by AT, keeping G₁ and G₂ unchanged. Assuming that private savings do not change, what will happen to the current account of the economy in period 1 ? (d) How would your answer to the previous question change if this was a large rather than a small open economy? Consider the government of a two-period small open economy where t = 1,2. Interest rates in the economy are given by ro= r₁=0.1. The government owns an initial level of government bonds B = -5. (a) Suppose that in period 1 the government spends G₁ = 10.5 and raises taxes for T₁ = 5. Compute the primary and secondary fiscal deficits of this government. Why do primary and secondary fiscal deficits differ? Does this country have to borrow in period 1? (b) In period 2, the government chooses G₂ = 11. What do taxes have to be in period 2, T2, in order for these levels of government expenditure to be sustainable? Compute the primary and secondary fiscal deficits of this country in period 2. (c) Suppose now that this government decides to lower taxes in period 1 by AT, keeping G₁ and G₂ unchanged. Assuming that private savings do not change, what will happen to the current account of the economy in period 1 ? (d) How would your answer to the previous question change if this was a large rather than a small open economy?

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