Answer to Question #274601 in Macroeconomics for Leena

Question

PROBLEM 1

Use the following news clip to work Problems 21 to 23.

Hong Kong Overflowing in Cash

In 2017, Hong Kong’s government debt was 43.9 percent of its nominal GDP. In the same

year, it witnessed a budget surplus of HK$138 billion. In March 2018, Paul Chan, Hong

Kong’s financial secretary, promised to return 40 percent of the surplus to the community

but stressed the importance of saving for the future.

Source: Bloomberg and ceicdata.com, March 2018

21. How does Hong Kong have a high debt percentage while also enjoying a large

surplus? How does debt financing affect monetary policy?

22. How would the budget surplus be affected if Hong Kong’s central bank decreased

interest rates?

23. a. How would Hong Kong’s budget surplus change in the 2018 and 2019 if its central

bank moved interest rates up?

b. How would Hong Kong’s budget deficit change in 2018 and 2019 if its central

bank’s monetary policy led to a rapid appreciation of the Hong Kong dollar?

Answer 1

21.This approach has several advantages.

First, there remains a sustainable long-term revenue management mechanism within the adopted budget rules. 

On the one hand, they increase the predictability and sustainability of fiscal policy, which has a favourable effect on the dynamics of major macroeconomic indicators, from long-term economic growth rates to the interest rate the government pays on its obligations (those who are financially well off are more willing to lend money). On the other hand, the positive effects of fiscal rules are more pronounced when governments set relatively tighter limits and, most importantly, do not allow them to be breached. In other words, budget rules, if not violated, are an important tool for building trust in the government and its ability to fulfill its obligations, which, in turn, positively affects economic growth.

Secondly, increased public spending through public borrowing provides an ideal balance between the interests of the population, businesses, the financial sector and the budget. banks are happy to lend to the government, which then 'injects' money into the economy through budget spending. 

Third, despite claims by global financial center leaders that the ultra-soft monetary policy will last, it is clear that it cannot last forever. Already on the horizon of three years there is the possibility of the start of a cycle of rising interest rates. At some point this cycle may coincide with another fall in oil prices (it has happened more than once in recent history). If you spend all reserves now, you will have to borrow in much less favorable conditions in the future and "slash spending alive".

So in both personal finances and public finances a "rainy day stash" is a useful thing, you should not try to get rid of it at the first opportunity. 

22.If the central bank of Hong Kong reduces interest rates, the budget surplus will increase, as the mechanism for activating economic growth will be launched.

23.The appreciation of the national currency may have a number of different consequences for the economy. Here are just a couple:

Export costs are rising: if the dollar rises, foreigners will find goods more expensive because they will have to spend more on these goods in dollars. This means that with a higher price, the number of exported goods is likely to decrease. Ultimately, this leads to a reduction in gross domestic product (GDP), which is definitely not an advantage.

Cheaper imports: If goods become more expensive on the foreign market, foreign goods or imported goods will become cheaper. This means that you can buy more goods imported from abroad. This leads to lower prices, which leads to lower overall inflation.

The budget deficit may increase and decrease