G Problem Set 7

G.1 Readings - Public Debt, Say’s Law

  1. Paul Krugman, Multipliers and Reality, New York Times Blog Post, June 3, 2015. What is the Chicago school’s argument against Keynesian multipliers? Why is it wrong, in Paul Krugman’s opinion?

  2. Glutology - Say’s Law: Supply Creates its Own Demand. The Economist, August 10, 2017. What view was Jean-Baptiste Say fighting? What poses a problem for Jean-Baptiste Say’s vision?

  3. Overlapping Generations: Kicking the road down an endless road. The Economist, August 31, 2017. How is a financial bubble similar in many ways to public debt, and to a pay-as-you-go system? How is it different?

  4. Greg Mankiw, The National Debt Is Still a Problem, New York Times, June 20, 2019. Why is National Debt still a problem according to Greg Mankiw? How do you make sense of his arguments through the overlapping-generations model?

  5. Alex Williams. “Why Don’t Rich People Just Stop Working?”, New York Times, October 17, 2019. How is this article connected to the issue of “Say’s law”, and to Keynesian economics?

G.2 A Budget Surplus and a Trade Deficit

The aim of this exercise is to better understand why, despite the first budget surplus in over 20 years, the U.S. still experienced a large trade deficit at the end of Bill Clinton’s presidency from 1998 to 2001.

We consider again the schematic redistributive policies from the rich to the poor, which we studied in lecture 9. We consider a reduction in taxes on the poor \(\Delta\underline{T}_{0}<0\), with an offsetting increase in taxes on high income earners such that \(\Delta T_0 = \Delta\underline{T}_{0}+\Delta\bar{T}_{0}=0\). We then have that \(\Delta\bar{T}_{0}=-\Delta\underline{T}_{0}>0\).

  1. What is the effect of redistribution on \(\Delta Y\)?

  2. What is the effect on the budget deficit of such a redistribution?

  3. Using directly that \(\Delta NX = -m_1 \Delta Y\), compute the trade deficit.

  4. We shall now decompose the trade deficit into saving and investment, to better understand the intuition behind the counterintuitive result. Compute first \(\Delta I\). Does it contribute to explaining the puzzle?

  5. Compute now private saving \(\Delta S\). Does it contribute to explaining the puzzle?

  6. Compute the net effect, total saving minus investment.

  7. Assuming that \(m_1=1/6\), \(b_1=1/6\), \(t_1=1/4\), \(\underline{c}_{1}=1\), \(\bar{c}_{1}=1/3\), \(\gamma=9\), \(\lambda=0.9\), what is the size of each component?

G.3 Coordination of Economic Policies

In this exercise, we shall consider the coordination of aggregate demand stimulating policies. We assume that consumption is given by \(C = 10+0.8 (Y-T)\), investment is given by \(I=8+0.1Y\), government spending is given by \(G = g_0 + 0.1Y\), taxes are given by \(T = 10+0.5Y\), and imports and exports are given by \(M = 0.1Y\) and \(X = 0.1 Y^{*}\), where \(Y^{*}\) denotes foreign output. We’re trying to give one potential justification for Donald Trump’s complaints to Germany (and China) - watch the video below.

  1. Given \(Y^{*}\), what is equilibrium output in the domestic economy?

  2. What is the multiplier in this economy, assuming that foreign output is given? (which cannot be true)

  3. If we were to close the economy - so exports and imports were identical, and net exports always equal 0. What would the multiplier then be?

  4. Assume that the foreign economy is characterized by the same equations as the domestic economy (with asterisks reversed). Use the two sets of equations to solve for equilibrium output of each country.

  5. What is the multiplier for each country now? Why is it different from the open economy multiplier in question 2?

  6. Write a geometric series to explain the intuition for the spillovers.

  7. What is the impact on Germany’s budget of a rise in U.S.’s government spending?

  8. What is the multiplier for a coordinated increase in government spending, such that \(\Delta g_0 = \Delta g_0^{*}\)?

  9. Is the multiplier then higher or lower than in the previous question? What is the economic intuition?

  10. Why is there a free-rider problem?

  11. Watch this statement by Donald Trump. Why might this exercise be an explanation for Donald Trump’s complaints on Germany’s (and China’s) economic policies?

G.4 Readings - Open Economy

  1. John Maynard Keynes. Proposals for a Revenue Tariff (March 7, 1931). What are the main arguments, in J.M. Keynes’ opinion, in favor of a revenue tariff? How would you use the model seen in the class to show this?

  2. Robert J. Barro, Stimulus Spending Keeps Failing; If austerity is so terrible, how come Germany and Sweden have done so well?, Wall Street Journal, May 9, 2012. What are Robert Barro’s main arguments against the Keynesian view? What would a Keynesian economist respond? (some of these arguments are given by Barro himself, but dismissed; you should find other arguments)

  3. Ben Bernanke. Germany’s trade surplus is a problem. Brookings Blog. April 3, 2015. Why does Germany have such a large trade surplus? Why is Germany’s trade surplus a problem according to Ben Bernanke?

  4. “Why Germany’s current-account surplus is bad for the world economy”, The Economist, July 8, 2017. What are the main arguments given by The Economist, which explain Germany’s large trade surpluses? Can you think of other arguments?

  5. Simon Tilford. “Germany Is an Economic Masochist.”, Foreign Policy, August 21, 2019. Denying the role of competitiveness, the author argues that “Germany produces far more than it consumes, because the country saves far more than it invests.” Explain why this argument is correct, but incomplete at the same time.