Twelve multiples choice questions for teaching the eurozone crisis to macroeconomic beginners

My good friend and colleague Gary Dymski (Economics Professor at University California, Riverside) has sent me 12 multiple choice questions that offer a wonderful training ground for macroeconomic novices. It would be interesting to make our European political leaders take it. How well do you think they would do?

1. Germany is considered the leading economy of the Eurozone. In 2006, it had a trade surplus with China and with the Southern countries of the Eurozone (Greece, Portugal, Spain). Germany has an marginal propensity to consume (MPC) of 4/5, t = 1/4, with a = 100, I = 200, G = 400, X = 600, Im = 300. What was the multiplier in Germany in 2006?

(a) 1.6

(b) 2

(c) 2.25

(d) 2.5

(e) 4

2. What was Germany’s GDP level in 2006?

(a) $1,500

(b) $1,750

(c) $2,000

(d) $2,500

(e) $2,800

3. Did Germany have a government surplus, a balanced budget, or a government deficit in 2006?

(a) a surplus of $400

(b) a surplus of $225

(c) it has a balanced budget

(d) a deficit of $225

(e) a deficit of $400

4. Could Germany’s economy, taken as a whole in 2006, be a net lender to other countries?

(a) yes, because it has a trade surplus

(b) yes, because it has a trade deficit

(c) no, because it has a trade surplus

(d) no, because it has a trade deficit

5. Suppose we consider the southern Eurozone countries of Portugal, Spain, and Greece as one integrated economy. Suppose further that the Portugal-Spain-Greece aggregate economy has the following parameters: b = 9/10; t = 1/6; a = 100; I = 100; G = 400; X = 150; Im = 300. What is the multiplier of the aggregate Portugal-Spain-Greece economy?

(a) 1.6

(b) 2

(c) 2.25

(d) 2.5

(e) 4

6. What is the equilibrium GDP per capita in this aggregate Portugal-Spain-Greece economy?

(a) $1,150

(b) $1,350

(c) $1,800

(d) $2,000

(e) $2,500

7. Does the aggregate Portugal-Spain-Greece have a government deficit or surplus?

(a) a deficit of $100

(b) a deficit of $200

(c) a surplus of $100

(d) a surplus of $200

8. Suppose that Germany’s banks made loans to Portugal-Spain-Greece in 2006 (and in other years) to cover the latter’s recurring government deficits. Everything is normal until 2010, when Portugal-Spain-Greece go into crisis. Specifically, I goes from 100 to 0, and X goes from 150 to 100. What will be the impact on the Portugal-Spain-Greece aggregate economy?

(a) its GDP will fall to $1400 and its government deficit will grow to $167

(b) its GDP will fall to $1000 and its government deficit will grow to $233

(c) its GDP will fall to $1200 and its government deficit will grow to $200

(d) its GDP will fall to $1400 and its government deficit will grow to $200

9. Portugal-Spain-Greece ask for an increase in loans to support their larger government deficit, from either the European Central Bank or from German banks. Politicians in Germany express outrage about this request. In their view, Germany has much more virtuous economic practices than Portugal-Spain-Greece. Which of these items could they list in ‘demonstrating’ Germany’s greater ‘virtue’?

(a) Germany has a government surplus, while Portugal-Spain-Greece have a government deficit

(b) Germany has a trade surplus, while Portugal-Spain-Greece have a trade deficit

(c) Germans have a higher rate of savings (their MPC is less) than in Portugal-Spain-Greece

(d) Government spending is a lower share of GDP in Germany than in Portugal-Spain-Greece

(e) all of the above

10. Germany brokers a deal in the Eurozone. The European Central Bank (which it controls) will provide emergency loans to Portugal-Spain-Greece to help them through the crisis; but only if the tax rate in these Southern countries is doubled, from 1/6 to 1/3. The point of this is that these Southern countries can shift from building up government debt to paying off the debt they owe. What will the new level of equilibrium GDP be in Portugal-Spain-Greece after this policy change is effected? [To reiterate, the Southern countries’ parameters will now be: b = 9/10, t = 1/3, a = 100, I = 0, G = 400; X = 100; Im = 300]

(a) the Portugal-Spain-Greece GDP will now equal $500

(b) the Portugal-Spain-Greece GDP will now equal $750

(c) the Portugal-Spain-Greece GDP will now equal $800

(d) the Portugal-Spain-Greece GDP will now equal $1000

11. After this doubling of the tax rate, will Portugal-Spain-Greece have a government surplus or deficit?

(a) a surplus of $200

(b) a surplus of $150

(c) a balanced budget

(d) a deficit of $150

(e) a deficit of $200

12. This solution is very painful for the Southern countries, whose GDP has fallen by more than 50% since the crisis hit. Suppose that the Prime Minister of one of these countries (Greece, Spain or Portugal) addresses the European parliament, as follows:

“Fellow Europeans, I ask that we find another way. We of the Southern countries are willing to pay higher taxes, as we are now doing. But this policy shift has not put our government budgets into surplus; we remain in deficit. And if we were to raise our tax rate again, even to 1/2 or to 2/3, this still would not generate the budget surplus we need to begin paying back our debt. What will generate a government surplus – with our new tax rate of 1/3 (which is more than you pay in Germany), is investment by the other countries of the Eurozone in our countries. If investment were to shift from 0 to 300 – investment that Germany can easily finance based on its trade surplus and government surplus – then we Southern countries can shift to a higher GDP and we will have a government surplus. I ask you to support this policy shift – I ask you to show that you believe in the future of Europe by investing in the Southern European countries before we collapse even further.”

Is the Prime Minister’s analysis correct?

(a) no, with a tax rate of 1/3 and a shift of I from 0 to 300, the GDP of Portugal-Spain-Greece will grow but these countries will still have a government deficit

(b) no, with a tax rate of 1/3 and a shift of I from 0 to 300, the GDP of Portugal-Spain-Greece will not grow, and these countries will still have a government deficit

(c) no, with a tax rate of 1/3 and a shift of I from 0 to 300, the government deficit of Portugal-Spain-Greece will be eliminated, but these countries’ GDP will not grow

(d) yes, with a tax rate of 1/3 and a shift of I from 0 to 300, the government deficit of Portugal-Spain-Greece will be eliminated, and these countries’ GDP will grow

(e) it is impossible to know if the Prime Minister is right

6 Comments

  • I think that German policy makers are interested in a different question: What interest rate on emergency financing will encourage peripheral countries to undertake austerity measures but will not destroy their economies? I doubt that a “right” answer exists…

    • You are ever so right. There exists no interest rate that will at once ‘punish’ deficit countries and prevent them from becoming insolvent. Which means that the solution will not come through loans to the deficit stricken countries. Thus, our Modest Proposal

    • Nah, the Germans are IMF’ing Southern Europe. It’s not about getting paid back, it’s about political dominance.

      So what they want to know is “what interest rates and conditionalities will make it just barely more attractive for these countries not to tell us to go whistle for our money?”

      – Jake

  • Where are we to find markets to dispose of the products resulting form further investment by Germany in southern Europe?In other words how can the problem of over-accumulation(over capacity,over-production of capital) ) be solved within the present socio-political structures? How are we to solve the problem within a dynamic framework e.g the Harod-Domar growth model?
    Answers to the questions: 1-d 2-d 3-b 4-a 5-e 6-c 7-a 8-c 9=? 10-b 11-d 12-d

    • Recycling of surpluses by investing in the defict areas would result in an increase in demand within the deficit regions for both the exports of the surplus regions and the new products produced in the deficit regions themselves. The trick is to avoid thinking in terms of a constant sum game.

  • Outlets for surplus may have existed in housing or infrastructure but the credit system has already exhausted the possibilities of both(i.e we already have the housing and real estate crisis in Ireland, Spain,U.K and U.S and the fiscal crisis of the state in all of these countries).In Contrast China successfully countered the crisis with a massive investment program.The U.S and the EU cannot achieve that,why? The answer lies in different socio-political structures.Kenneth Galbraith realized that 40 years ago when he advocated nationalization of large corporations and banks in U.S.in his book “The new industrial state”