Many people believe that Congress will eventually have to reduce Social Security benefits in order to reduce the budget deficit. Although most of the changes would not take place until later, assume for the purpose of this problem that Social Security benefits were cut today by $100 billion per year.

A) If the marginal propensity to consume is 0.8, explain what the long-run effects would be on real GDP, public saving, and national saving.

B) The US is a large open economy with a trade deficit. Use the appropriate graphs to illustrate and state what the reduction in Social Security benefits would do to each of the following in the long run: national saving, investment, the US real interest rate, net capital outflows, the real exchange rate, and the trade deficit.

C) Now, consider the small open economy of Norway, which has a trade surplus. If the US, a large open economy, were to reduce its Social Security benefits, use the appropriate graphs to illustrate and state what would happen in the long run to Norway’s national saving, investment, interest rate, real exchange rate, and trade surplus.