• Question on test 1; commenting on the statement
1) Is confidence important in the economy?
2) Is the policy of restoring confidence the correct policy?
4) Impact of a balanced budget?
Case Study #3 Austerity
1) Government Austerity
• Definition: government trying to reduce expenditure
• Rational behind that the view that austerity will help economic growth
o The belief that consumer and business sector are not spending because they
don’t have confidence in the economy due to a budget deficit
2) Is confidence necessary?
• It is crucial
• With confidence comes spending
• Krugman – confidence fairy:
3) Why austerity cannot be expansionary
• As government expenditure goes down, equilibrium income will be reduced
• It will not improve confidence
4) Does government spending takes resources away from private sector
• Not going have a particular crowding out effect
• There is excess capacity in the economy, producing goods for the government will not
take away goods available for the other sectors
• Must be careful in applying models
o In lecture slides, that demand/supply will not change, in the real world its different
5) Those who are against austerity measures • Depends on the state of the economy
• Fiscally responsible?
o Balance budget over business cycle
o Structural deficit needs to be corrected
o Cyclical deficit is normal
• When to worry about inflation?
o Immediate inflation is not evident since the economy is in recession
Interest rate is close to 0%
o Worry when there are pressure for prices to increase
6) Expansionary austerity view
• Negative correlation between debt of gov