Based on the experience of Russia and China over the past few years, Western businesses are concerned that the budget and the inflation rate in Freedonia will spiral out of control. Because of these fears, they have been hesitant to invest in Freedonia. In an attempt to reassure foreign investors, the Freedonian government has published an economic plan for the next several years. The government thinks that real GDP can continue to grow at a rate of 3.5 percent for at least the next decade. All tax revenue is generated by a value-added tax that collects 20 percent of GDP. The government proposes to keep this tax rate constant far into the future, and also to let its purchases and transfer payments grow by 3.5 percent per year in real terms, so that they remain fixed as a fraction of GDP. The government promises to bring the inflation rate down to 2.5 percent per h 2.5 percent inflationyear within two years, and it has already adopted a money growth rate that is consistent wit a. What rate of money growth is consistent with 2.5 percent inflation? Why? b. Given this rate of money growth, how much revenue will the government generate from money growth this year? Calculate the conventional government budget deficit. Calculate the primary government budget deficit. Calculate the real government budget deficit. 4 Do you think the government can keep all of the promises listed above? If C. d. e. f.
Based on the experience of Russia and China over the past few years, Western businesses are concerned that the budget and the inflation rate in Freedonia will spiral out of control. Because of these fears, they have been hesitant to invest in Freedonia. In an attempt to reassure foreign investors, the Freedonian government has published an economic plan for the next several years. The government thinks that real GDP can continue to grow at a rate of 3.5 percent for at least the next decade. All tax revenue is generated by a value-added tax that collects 20 percent of GDP. The government proposes to keep this tax rate constant far into the future, and also to let its purchases and transfer payments grow by 3.5 percent per year in real terms, so that they remain fixed as a fraction of GDP. The government promises to bring the inflation rate down to 2.5 percent per h 2.5 percent inflationyear within two years, and it has already adopted a money growth rate that is consistent wit a. What rate of money growth is consistent with 2.5 percent inflation? Why? b. Given this rate of money growth, how much revenue will the government generate from money growth this year? Calculate the conventional government budget deficit. Calculate the primary government budget deficit. Calculate the real government budget deficit. 4 Do you think the government can keep all of the promises listed above? If C. d. e. f.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:Based on the experience of Russia and China over the past few years, Western businesses are
concerned that the budget and the inflation rate in Freedonia will spiral out of control. Because
of these fears, they have been hesitant to invest in Freedonia. In an attempt to reassure foreign
investors, the Freedonian government has published an economic plan for the next several
years.
The government thinks that real GDP can continue to grow at a rate of 3.5 percent for at least
the next decade. All tax revenue is generated by a value-added tax that collects 20 percent of
GDP. The government proposes to keep this tax rate constant far into the future, and also to let
its purchases and transfer payments grow by 3.5 percent per year in real terms, so that they
remain fixed as a fraction of GDP. The government promises to bring the inflation rate down to
2.5 percent per h 2.5 percent inflationyear within two years, and it has already adopted a
money growth rate that is consistent wit
a. What rate of money growth is consistent with 2.5 percent inflation? Why?
b.
Given this rate of money growth, how much revenue will the government
generate from money growth this year?
Calculate the conventional government budget deficit.
C.
d.
Calculate the primary government budget deficit.
e.
Calculate the real government budget deficit.
f.
Do you think the government can keep all of the promises listed above? If
yes, why? If no, why not, and how might the actual results differ from the promised
results?
Transcribed Image Text:Q. The following table contains some macroeconomic data for the hypothetical
country of Fredonia, which formerly had a Marxist economy but has recently
converted to a market system. Except for the inflation, unemployment, and real
growth rates, the numbers are in millions of local currency.
GDP
Public Debt
High-Powered Money
Government Purchases
Government Transfer Payments
Government Nominal Interest Payments
Tax Revenues
Unemployment Rate
Growth Rate of Real GDP
Inflation Rate
5,000 million
4,000 million
500 million
500 million
600 million
560 million
1,000 million
5.5 percent
3.5 percent/year
10.0 percent/year.
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