Question

Question one

During recent years,   the global economic crisis has thrown a   spotlight on different governments’ attitudes to debt and borrowing. It is therefore important to understand opposing views on government borrowing, as well as the mechanisms of borrowing.

(a)        Explain the difference between ‘automatic stabilization’ and ‘discretionary

stabilization’.   

(b)        Explain why a government may have difficulty in implementing discretionary

stabilization successfully.       

(c)        Explain why monetarists would argue that control of inflation is the most

effective method of achieving growth in the economy.          

(d)        In terms of debt instruments, distinguish between the primary and secondary

market and discuss the implications for liquidity if an instrument is not tradable on the secondary market.            

(e)        Define the following terms associated with borrowing

i.          Residual maturity       

ii.   Euro bonds (1)

iii. Strips         (1)

iv. Index-linked bonds           

(f)        Describe the economic effects associated with a government using bills or

bonds to borrow from overseas.         

Answer 1

(A)

Automatic stabilizers are limited in that they focus on managing the aggregate demand of a country. Automatic stabilizers exist prior to economic booms and busts.

Discretionary policies can target other, specific areas of the economy. Discretionary policies are enacted in response to changes in the economy

(B)

The discretionary fiscal policy does not always work as intended by the government. There are many reasons, why the fiscal policy may not be as effective as expected.

✓If the government relies on inaccurate statistics, then it’s likely to make wrong policy decisions in the first place.
✓The economy may be slow because of shortage of resources rather than lower demand
✓There could be a lag in implementing a policy decision, and/or the impact of a policy decision.
✓Since expansionary fiscal policy increases fiscal deficit, there is constraint over how much deficit the government can tolerate.

(C)

Inflation causes trouble for economic systems in four interrelated ways. Inflation erodes the money unit’s purchasing power— the so-called “inflation tax.” Anticipation of further erosion reduces people’s desire to hold money and other assets denominated in the money unit. This may have certain favorable short-term consequences, but on balance the longer-term consequences are assuredly negative.

(D)

• The primary market is where securities are created, while the secondary market is where those securities are traded by investors. In the primary market, companies sell new stocks and bonds to the public for the first time, such as with an initial public offering (IPO), treasury bill etc.
• in the secondary market, investors trade previously issued securities without the issuing companies' involvement the secondary market is basically the stock market and refers to the New York Stock Exchange, the Nasdaq,