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Dornbusch & Fischer

(l) What is considered a high budget deficit?

A budget deficit is the excess of government expenditures over government revenues. Government expenditures pertain to government spending on purchases of goods and services, subsidies provision, and transfer payments. Government revenues, however, consist of tax receipts and other revenues. Budget deficits of 3% to 6% as a percentage of GDP are already high, as experienced by the United States in the 1980’s and early 1990’s. Budget deficits are financed by government debts- government- issued bonds that promise payment upon maturity (Dornbusch & Fischer, 1994).

(2) What is a budget surplus?

A budget surplus is the excess of government revenues over government expenditures. Government revenues consist of taxes and other revenues. Government expenditures, however, include government purchases of goods and services, subsidies, and transfer payments. Japan is an example of a country with a budget surplus, with a budget surplus average of 2% of GDP from 1987 to 1992 (Dornbusch & Fischer, 1994).

(3) Why do we have to fight inflation?

Inflation is the increase in the general level of prices of goods and services. The inflation rate measures the rate of change in an economy’s general price level. Inflation is an economic issue, one which the general

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public has an understandably strong aversion for. Inflation effects in a wealth redistribution effect; unexpected inflations lower the purchasing power of all assets and claims with fixed money terms (e.g. money, savings accounts, bonds, insurance), thereby according some factions of an economy unexpected gains at the expense of other factions (Dornbusch & Fischer, 1994). Secondly, economic efficiency is impaired from a distortion in price mechanisms. Total output is likewise affected (Samuelson & Nordhaus, 1995). Third, inflation leaves the public with higher tax payments from a reduction in real disposable income. Indexing of tax brackets, however, offers a promising solution (Dornbusch & Fischer, 1994). Lastly, inflation distorts the measurement of income and the public’s use of money (Samuelson and Nordhaus, 1995).

(4) How do we fight inflation?

The threat of an impending inflation can be contained by government intervention. The Federal Reserve can reduce money growth as a high growth of money triggers inflationary tendencies. Lowering the growth rate of money will lower the aggregate demand, thereby lowering the inflation rate and output (Dornbusch & Fischer, 1994). Secondly, the Federal Reserve can also raise interest rates in order to restrain the real output growth and increase unemployment (Samuelson & Nordhaus, 1995). There is an inflation-unemployment tradeoff, a relationship that is described by the Phillips curve.

(5) What is a recession?

A recession is a downturn in a business cycle, technically a period when “real GDP declines for at least 2 consecutive quarters”. Recessions are usually characterized by (1) real GDP falls as a result of a sharp decline in consumer purchases followed by total output decreases, (2) layoffs and high unemployment from a lower demand for labor, (3) deflation from a lower demand for goods and services, (4) fall in business profits and common-stock prices, (5) fall in the growth of real wages, and (6) lower interest rates from a higher credit demand (Samuelson and Nordhaus, 1995).

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