Functions and Budget of Government

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Questions and Answers

What is the primary focus of fiscal policy as described?

Managing government borrowing exclusively

Strategic investments in infrastructure (correct)

Regulating the supply of money in circulation

Controlling interest rates through banking systems

Which entity is primarily responsible for monetary policy?

Central banks and banking institutions (correct)

International organizations

National governments

Private financial firms

In the context of economic policy, what is a significant role of government spending?

Increasing taxes on small businesses

Reducing public sector employment

Enabling strategic investments like digital and green infrastructure (correct)

Facilitating immediate personal loans to citizens

What does monetary policy primarily control?

The quantity of money available in the economy Signup and view all the answers

Which component is NOT typically associated with fiscal policy?

Interest rate adjustments Signup and view all the answers

What is one primary function of the government in relation to market competition?

Preserve market competition Signup and view all the answers

Which of the following is a key component considered in public budget expenditures?

Interest payments on public debt Signup and view all the answers

Why is excessive public debt considered unsustainable?

Every extra dollar generates additional interest payments Signup and view all the answers

What is the role of the central bank concerning government public debt?

To directly purchase public debt from the government Signup and view all the answers

What happens to the public budget balance (PBB) when public debts are issued?

PBB decreases and generates higher interest payments Signup and view all the answers

What is a primary way the government aims to stimulate the economy during recessions?

Increasing public consumption and redistribution Signup and view all the answers

Which of the following statements about public sector debt in developed countries is true?

Central Bank purchases of public debt are generally forbidden Signup and view all the answers

What underlying issue might suboptimal market outcomes lead to?

Heightened economic inequality Signup and view all the answers

What happens to borrowing costs when the base interest rate is lowered?

Borrowing becomes cheaper. Signup and view all the answers

What is the effect of lower interest rates on the market?

They lead to higher demand for loans. Signup and view all the answers

Which tool is commonly used for influencing money supply in the economy?

Open Market Operations Signup and view all the answers

What does a minimal reserve coefficient imply for banks?

Banks can loan out a greater portion of deposits. Signup and view all the answers

What is a potential consequence of lowering the base interest rate?

Consumer spending may increase. Signup and view all the answers

Which of the following is NOT a result of decreasing the base interest rate?

Reduced market participation. Signup and view all the answers

In which situation would one expect a reduction in the minimum reserve coefficient?

When monetary policies aim to increase liquidity. Signup and view all the answers

What is a likely outcome of conducting Open Market Operations?

Adjustment of money circulation in the economy. Signup and view all the answers

What is the relationship between reserves and deposits in a banking system?

Reserves can be less than deposits due to fractional reserve banking. Signup and view all the answers

Which monetary policy tool is used to control the money supply through interest rates?

Official interest rate adjustments. Signup and view all the answers

Why can an expansionary monetary policy risk deflation?

It can create an environment of low consumer spending. Signup and view all the answers

What can be included as securities within a bank's asset balance sheet?

Corporate bonds and public bonds. Signup and view all the answers

What occurs when banks lend more than their reserves?

Risk of bank insolvency. Signup and view all the answers

What is indicated by a currency being in circulation?

The currency is physically exchanged among the public. Signup and view all the answers

Which statement is incorrect regarding reserves in a bank's balance sheet?

They are irrelevant to determining liquidity. Signup and view all the answers

Which of the following would be considered a contractionary monetary policy?

Increasing the official interest rate. Signup and view all the answers

What is the primary risk associated with excessive reliance on public and corporate bonds by banks?

Market volatility and credit risks. Signup and view all the answers

What does 'money supply' refer to within a banking context?

The total of money in all forms, including deposits. Signup and view all the answers

How does an increase in reserves impact the economy?

It increases the banks' ability to lend. Signup and view all the answers

What is a potential effect of implementing an official interest rate of zero?

Greater incentives for borrowing. Signup and view all the answers

What role do deposits from other banks serve in a bank's balance sheet?

They increase the available funds to lend out. Signup and view all the answers

Which of the following best defines 'fractional reserve banking'?

A system allowing banks to lend a portion of their deposits while maintaining reserves. Signup and view all the answers

What is one potential consequence of the central bank buying all types of financial assets?

Creation of financial bubbles Signup and view all the answers

What challenge does the environment pose for foreign direct investment in China?

Environmental regulations Signup and view all the answers

Which of the following is NOT a disadvantage for foreign direct investment in China?

Unstable political climate Signup and view all the answers

What is indicated to potentially happen if inflation is not controlled by the central bank?

Inflationary effects Signup and view all the answers

In the case of Greece, what was the government facing due to high levels of debt?

Very high interest payments on debt Signup and view all the answers

What role does the central bank play in relation to banking systems during financial panic?

Acting as a lender of last resort Signup and view all the answers

What is a challenge mentioned regarding China's labor force?

Aging population Signup and view all the answers

What was a significant impact observed in China after 25 years regarding foreign direct investment?

It turned negative for the first time. Signup and view all the answers

Which of the following is NOT mentioned as an issue affecting foreign direct investment in China?

Strong consumer demand Signup and view all the answers

What issue does the circular flow model face during a pandemic in terms of economic dynamics?

Issues with liquidity and flow of resources Signup and view all the answers

Which of the following factors contributes to the negative view on foreign direct investments in China?

Weak transparency in business practices Signup and view all the answers

What can occur if too much liquidity is introduced into the market without caution?

Potential for asset bubbles Signup and view all the answers

Which issue is commonly acknowledged as influencing corporate decisions in China?

Cultural differences Signup and view all the answers

What was one major consequence of the housing market crash that sparked the Great Recession?

Global financial instability. Signup and view all the answers

What is one potential drawback of the Euro as a common currency among the Eurozone countries?

Loss of individual national monetary policy control. Signup and view all the answers

Which of the following best describes the Stability and Growth Pact within the EU?

It enforces fiscal discipline during economic downturns. Signup and view all the answers

What is the primary goal of the 'Made in China 2025' initiative?

To transition to higher-tech industries. Signup and view all the answers

What is a significant challenge facing the Chinese economy that can create vulnerabilities?

Over-reliance on traditional manufacturing. Signup and view all the answers

What distinguishes Real GNP from Nominal GNP?

Real GNP reflects inflation-adjusted values. Signup and view all the answers

Which of the following accurately describes hyperinflation?

An extreme form of inflation that exceeds 10% per year. Signup and view all the answers

What is a significant result of a financial account surplus in relation to the current account?

Offsetting a current account deficit. Signup and view all the answers

How is economic growth quantified?

As the percentage increase in Real GDP. Signup and view all the answers

What does the Consumer Price Index (CPI) primarily measure?

The average prices of a basket of consumer goods. Signup and view all the answers

What characterizes demand-driven inflation?

A rise in aggregate demand exceeding supply. Signup and view all the answers

Which of the following best describes national income (NI)?

GNP minus depreciation and indirect taxes, plus subsidies. Signup and view all the answers

What is a primary goal of the central banks when managing monetary policy?

To stabilize inflation and foster economic growth. Signup and view all the answers

What was a significant global response to the Great Recession of 2008-2009?

Adoption of expansionary fiscal policies to increase public spending. Signup and view all the answers

Which of the following is a drawback of the Euro as a common currency within the Eurozone?

Loss of independent monetary policy for individual countries. Signup and view all the answers

What is a primary objective of the Stability and Growth Pact in the European Union?

To ensure government deficits are maintained below 3% of GDP during economic downturns. Signup and view all the answers

What does the 'Made in China 2025' policy primarily aim to achieve?

To transition China from a focus on low-end manufacturing to high-tech industries. Signup and view all the answers

What is one main risk associated with the Euro's common currency system?

Potential economic disparities leading to regional imbalances. Signup and view all the answers

What is Real GNP adjusted for?

Base-year prices to remove inflation effects Signup and view all the answers

Which type of inflation is characterized by excessive price increases exceeding 10% per year?

Hyperinflation Signup and view all the answers

What aspect does the Balance of Payments Current Account primarily track?

All economic transactions with the rest of the world Signup and view all the answers

What is a primary goal of monetary policy as managed by central banks?

Ensuring price stability and promoting growth Signup and view all the answers

What economic measure is used to gauge economic growth?

Percentage increase in real GDP Signup and view all the answers

What occurs in the Balance of Payments equilibrium?

Current account deficit is met by a financial account surplus Signup and view all the answers

What phenomenon is described as negative inflation leading to economic stagnation?

Deflation Signup and view all the answers

Which of the following economic tools is generally associated with fiscal policy?

Taxation and government spending Signup and view all the answers

Study Notes

Functions of Government

Preserve market competition
Correct suboptimal market outcomes
Redistribution
Fight recessions
Steer the economy in the long run

Public Budget

A record of all revenues & expenditures
Revenues: Taxes (e.g., Consumption Taxes)
Expenditures:
- Public Budget Deficit:
 - Monetization: Central Bank purchases public debt directly from the government
 - Forbidden in most developed countries to ensure the independence of Monetary Policy
 - Selling Public Debt in Bond Markets: Issue public bonds (T-Debt) to investors
 - Why excessive debt is not sustainable?
 - PBB < 0 -> ↑ Interest Payments -> ↑ PBB -> Every extra E generates add interest payments
- Downsides of Public Debt:
 - Siehe Slides !!
- Government spending allows for strategic investments:
 - Infrastructure
 - Digital green, reliable (EU-Covid-19)

Economic Policy (Class Session 2)

Fiscal Policy: (Siene Slide davor)
Monetary Policy: (Central Banks Banking Institutions)
- Definition: All policies that allow for control of the quantity of money available in the economy for immediate use
- How do we create money?
  - Reserve Requirement: Reserves in circulation = 1000E / Reserve requirement (rc) = 20%
  - Step 1:
    - Bank 1 receives 1000E in deposits, with 200E reserves and 800E loans.
    - Bank 1 loans out 640E.
    - Bank 2 receives 640E in deposits and keeps 20% (128E) in reserves and loans out the remaining 512E.
    - This process continues, and the money supply expands.
  - Money supply: 1000E / 20% = 5000
- Balance Sheet of a "Modern Bank":
  - Assets:
    - Reserves
    - Cash in CB
    - Deposits from other Banks
    - Loans given
    - Public Bonds
    - Corporate Bonds
- Tools:
  - Conventional Monetary Policy Tools:
    - Official interest rate (i):
      - Expansionary: ↓ i
      - Contractionary: ↑ i
    - Minimum Reserve Coefficient (rc):
      - This is the most used tool for controlling the money supply
    - Open Market Operations (GMO)
      - The CB directly buys all types of financial assets to force a decrease on interest rates.
      - Example: Greece - the government had to pay very high interest on its debt.
        
        ECB/FED (secondary market) buys Greek bonds.
        
        This leads to an increase in demand for government bonds, which lowers interest rates.
      - Effects:
        
        Huge impact on the size of the ECB/FED Balance Sheet.
        
        Negative effects:
        
        Very inflationary if not stopped in time.
        
        Potential creation of bubbles.
- The Circular Flow and the Pandemic:
  - The CB is responsible for being the lender of last resort for the banking system to avoid financial panic.
- China Case:
  - China is labor-intensive transitioning toward a capital-intensive country.
  - Facts:
    - FDI in China turned negative for the first time in 25 years.
  - Disadvantages of FDI in China:
    - An ever-changing legal environment.
    - Bureaucratic & administrative complexities.
    - Aging population & cultural differences.
    - High level of corporate indebtedness.
    - Overcapacity in several sectors of production.
    - A lack of transparency & weak intellectual property rights protection.
    - Underdeveloped middle management.
Message: Government (Chinas institutions) should work to make the country attractive for companies to move their operations there.

Introduction to Global Economics

Gross National Product (GNP): Measures the market value of final goods/services produced by a nation's factors of production. Real GNP adjusts for inflation using base-year prices.
Gross Domestic Product (GDP): Total value of goods/services produced within a country's borders. Understanding its components is crucial. Nominal GDP uses current prices, while real GDP accounts for inflation.
Economic Growth: Percentage increase in real GDP.
National Income (NI): Calculated as GNP minus depreciation and indirect taxes, plus subsidies.
Inflation: A general increase in prices. Measured using the Consumer Price Index (CPI). Central banks typically target inflation around 2%.
Types of Inflation: Demand-pull (rising aggregate demand) and cost-push (decreased production). Hyperinflation exceeds 10% annually. Deflation is a decrease in prices, potentially harming economic activity.
Unemployment: Key metrics include the unemployment rate and labor force participation rate. Government aims to reduce unemployment and manage economic growth.
Balance of Payments: Records all economic transactions between a nation and the rest of the world.
- Current Account: Tracks trade in goods, services, and income.
- Financial and Capital Account: Covers transactions in financial assets (investments, loans).
- Equilibrium: Achieved when current account deficits are balanced by financial account surpluses. Changes in foreign exchange reserves are relevant here.

Macroeconomic Variables and Policy

Fiscal Policy: Government tools (spending and taxation) to influence the economy. Goals include managing economic growth and stability.
Monetary Policy: Central banks (e.g., ECB, Federal Reserve) control interest rates and the money supply to manage inflation and growth. Conventional and unconventional tools (like Quantitative Easing or QE post-2008) are used.
The Great Recession (2008-2009): Originated in the U.S. housing market, causing global financial crisis. Governments responded with expansionary fiscal policies (increased spending) to prevent collapse.

The European Economy

European Union (EU): Political and economic union of 27 member states.
Eurozone: Countries using the euro.
Stability and Growth Pact: Limits government deficits (to 3% of GDP) to ensure fiscal discipline within the Eurozone, particularly during recessions.
Next Generation EU – Recovery Plan: A significant post-crisis recovery initiative.
The Euro: Offers benefits like eliminating exchange rate uncertainty and promoting integration, but also leads to a loss of national monetary policy control and fiscal constraints. The concept of Optimal Currency Areas is relevant to its evaluation.

China: Economic Policy and Transformation

Economic Reforms: China aims to transition from low-end manufacturing to higher-tech industries (Made in China 2025). The semiconductor industry is particularly important in this transition.
Economic Imbalances and Vulnerabilities: Understanding these is crucial for analyzing China's economic future.
Taiwan Case: This region's role in the global semiconductor industry and its geopolitical significance in relation to China's ambitions should be considered.