Posted: November 26th, 2015

Macroeconomics

Macroeconomics

A. Following Carlin & Soskice page 520, Greece has a debt to GDP ratio of 180% (http://www.nytimes.com/2015/07/15/business/international/international-monetary-fund-proposed-greek-debt-relief.html?_r=1). The real interest rate on its 10-year bonds (http://www.bloomberg.com/quote/GGGB10YR:IND) is 10%. If the real Greek economy is growing at a rate of 3% per year, and we want to keep the debt/GDP ratio stable, what must be d = (G-T)/Y, Greece’s primary balance? Briefly explain what your answer means.
(?b = d + (r – ?y)*b)

B. Since Greece is experiencing an economic downturn worse than the Great Depression in the US, with output perhaps25% below its potential (http://econbrowser.com/archives/2015/07/possible-scenarios-for-greece), it would like to run a primary balance that’s smaller in magnitude that what we found in part (A). Suppose that the multiplier on RGDP for a change in d was 1.5, and Greece wanted to raise its GDP by 15% (so it would only be 10% below potential). Greece could do this by defaulting on some of its debt (thus reducing its debt/GDP ratio). By how much would Greece need to reduce its debt/GDP ratio b to keep move its d sufficiently to raise Greek real GDP by 15% while keeping b stable going forward? (?b = d + (r – ?y)*b)

C. Suppose that everything in (B) still holds but instead of reducing b, Greece re-negotiates to get a lower interest rate on its outstanding debt. How much would the real interest rate on its debt need to fall to keep b stable while raising d sufficiently to increase Greek RGDP by 15%? (?b = d + (r – ?y)*b)

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