(15) EK (Economic Knowledge) — Government Debt and Inflation, Sectoral Balances, and Primary Fiscal Surpluses

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1. Issuing government debt reduces the risk of inflation arising from deficit spending because the private sector has less money to spend. 

True or false?

My answer: false.

My explanation: Spending by a currency issuing government does not depend on tapping into/depleting (a finite fund of) money held by the private sector. Selling debt (bonds) is only one way in which the government (central bank really) ensures that the target (interest) rate it deems desirable can be maintained — it is a monetary operation, and not a means to fund government spending. The private sector's net worth is not affected by this operation.

2. If net exports are running at 2 per cent of GDP, and the private domestic sector overall is saving an equivalent of 3 per cent of GDP, the government must be running a surplus equal to 1 per cent of GDP.

True or false?

My answer: false.

My explanation: Net savings by the private domestic sector must be "financed" by deficits in at least one of the other two sectors — the government sector and the rest of the world. With the rest of the world being in deficit vis-à-vis the country in question to the tune of 2 % of GDP, the remaining savings of 1 % must be covered by a government deficit of 1%.

3. To reduce the public debt ratio, the government has to eventually run primary fiscal surpluses.

My answer: false.

My explanantion: If the stimulus induced by deficit spending is strong enough, GDP may grow more than public debt, reducing the public debt ratio.

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