5. Fiscal Policy and Current Account (Total 10 Points). From the Financial Times

Question

5. Fiscal Policy and Current Account (Total 10 Points). From the Financial Times May 15, 2017 “The International Monetary Fund has called on Germany to spend more on infrastructure, childcare, refugee integration, and introducing income tax cuts. Alongside using fiscal space, the IMF also advocated pension reforms that would make it more attractive for Germans to work longer — addressing problems associated with a population that is aging at a faster pace than anywhere else in the world bar Japan.” a) How will these two actions affect the current account of Germany (be explicit about whether the effects of the two policies go in the same direction)? (5 points) b) In the same article: “The German economy has grown strongly in recent years but Fund officials called on policymakers here to do more to boost growth potential.” How does this recommendation change the potential response of the ECB (European Central Bank) to increases in infrastructure spending? (5 points)

Explanation / Answer

a. The above mentioned policy decisions are associated with expansionary fiscal policy of the government. This might lead to increase in fiscal deficit of the government and thus might increase current account deficit of the German government.

b. This might lead ECB to increase its infrastructure lending in order to increase government expenditure which will increase overall aggregate demand of the economy. Thus, ECB will increase its infrastructure lending.

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