Which of the following is a reason a government might increase government spending quizlet?

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The current recession does require a re-evaluation of the role fiscal policy can play when interest rates hit a zero bound. An expansionary fiscal policy is required because monetary policy-makers are reluctant to promise higher future inflation, and the impact of quantitative easing is likely to be small.

One theory suggests that if US monetary policy had raised US interest rates more quickly after 2001, the credit crunch could have been avoided. Conclusions rely on a crucial argument, which is that low nominal interest rates lead to a 'search for yield' that encourages excessive risk-taking. This idea is certainly not part of standard economic theory, where preferences for risk are not normally endogenous to the level of interest rates.

The credit crunch does not represent a failed macroeconomic policy, but a large negative macroeconomic shock generated by a failure of financial regulation.

The key limit is not when a government will probably default, but when the possibility that it will default becomes significant enough for lenders to require a risk premium to offset this chance.

To sum up, the consensus assignment needs qualifying in two important ways. First, it is prudent to use fiscal policy in a counter-cyclical manner when there is a significant possibility that interest rates might hit the zero bound. (It should certainly be used once the lower bound has been hit.) Second, there may be many cases in which it is useful to use changes in specific taxes when they operate on the same margin as distortionary shocks, or when they can change relative prices that are away from efficient levels because of nominal inertia.

Our main result is that whereas the link between growth and debt seems relatively weak at "nor- mal" debt levels, median growth rates for coun- tries with public debt over roughly 90 percent of GDP are about one percent lower than other- wise.

Sharply rising interest rates, in turn, force painful fiscal adjustment in the form of tax hikes and spending cuts, or, in some cases, outright default.As countries hit debt tolerance ceilings, market interest rates can begin to rise quite sud- denly, forcing painful adjustment.

It is evident that there is no obvious link between debt and growth until pubic debt reaches a threshold of 90%.

Over the past two centuries, debt in excess of 90 percent has typically been associated with mean growth of 1.7 percent versus 3.7 percent when debt is low (under 30 percent of GDP), and compared with growth rates of over 3 percent for the two middle categories (debt between 30 and 90 per- cent of GDP).

Of course, there is considerable variation across the countries, with some coun- tries such as Australia and New Zealand experi- encing no growth deterioration at very high debt levels.

For emerging economies - o For 1900-2009, for example, median and aver- age GDP growth hovers around 4-4.5 percent for levels of debt below 90 percent of GDP, but median growth falls markedly to 2.9 percent for high debt (above 90 percent); the decline is even greater for the average growth rate, which falls to 1 percent.

Outside of the eurozone, the problem is that we have too little government debt, rather than too much.

There is a straightforward reason why the current debt crisis is largely confined to the euro area, which can be summed up in one short statement: these countries cannot print their own currency. • As De Grauwe (2011) points out, eurozone governments can be subject to the equivalent of a bank run. If no one buys their debt, they will be forced to default. Lenders may decline to buy their debt because they believe that ultimately those governments do not have the political will to raise the taxes to cover their spending in a sustainable way: this is the equivalent of an insolvent bank.

Both Keynesian macroeconomics as taught to first-year undergraduates and the state of the art Keynesian macroeconomics used by central banks tell us that the optimal response to the twin problems of deficient demand in the short run and excessive debt in the long run is a fiscal stimulus today followed by austerity when the recovery is assured.

Governments are subject to 'deficit bias': the tendency for government debt as a share of GDP to drift up over time. Evidence over the last 40 years (but perhaps not over a much longer time frame) is consistent with deficit bias (Calmfors and Wren-Lewis 2011). There is a good economic case for arguing that, over the long term, government debt in relation to GDP should be a lot lower than levels seen before the start of the recession. The incorrect inference is that this means that the process of reducing debt has to be unconditional and rapid. Once again, all the macroeconomic analysis (Keynesian or otherwise) suggests the opposite: debt should be allowed to respond to macroeconomic shocks, and debt correction should be gradual and context sensitive (Wren-Lewis 2011).

A simple analogy has some power here. If someone is overweight, what would you be more impressed by: a person who analyses why they are overweight, and embarks on a long-term plan (with suitable checks) to correct the problem, or someone who goes on a crash diet?