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Econ

Question
By late 2009, Greeces national debt had grown so large relative to the size of its economy that lenders had lost confidence in the Greek governments capacity to service it. Fear of a Greek default led to contagion – Spain, Italy, Portugal, and Ireland were all subject to the disapproving glare of frightened lenders. The crisis caused seismic disruption in Europe and the rest of the world.
The International Monetary Fund, the European Commission, and the European Central Bank reluctantly offered Greece bail-out loans – but with strings attached. In order to get the money, Greece had to agree to austerity measures. In this context, austerity means tight fiscal policy – that is, higher taxes and/or lower government spending in order to shrink Greeces annual budget deficit.
Using your knowledge of the impact of the governments budget on the equilibrium level of real GDP, and your understanding of the effect of the economy on the state of the governments budget, explain why austerity measures usually result in less improvement in the governments budget position than policymakers had hoped for. Be sure to define what we mean by the governments budget.


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