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ECO209 - NOV 05 Case Study 3.docx

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University of Toronto St. George

• 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? 3) 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 Assumptions 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
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