1. Ricardian equivalence (10) 

Explain in 150 words or fewer why, if households understand the government’s budget constraint and face the same interest rate as the government, a tax cut will have no effect on output. 

2. Sustainable deficits (10) 

(a) Why should governments avoid high levels of debt? 

(b) If the real interest rate is less than the growth rate of output, explain why governments can run a deficit yet not have to worry about the size of their debt. 

3. The zero lower bound and deflationary spirals (15) 

(a) What are the two mechanisms which can lead to deflationary spirals? 

(b) Using the three-equation model, analyse the impact of a negative demand shock which causes the nominal interest rate to fall to zero 

(c) What can policy do in this case to avoid a deflationary spiral? 

4. Write a few lines relating the following concepts to current economic events 

(15) 

(a) The multiplier 

(b) Crowding out 

(c) The permanent income hypothesis 

(d) The sustainability of government debt 

(e) The yield curve