Chapter 13

Non- discretionary fiscal policy

passive or automatic fiscal policy

state fiscal policy is ____________ because they have legal requirements to annually balance their budgets

pro-cyclical

The federal government can meet its obligations by

refinancing maturing treasury securities, increase taxes, and create money

When the federal government runs a budget deficit, it makes up the difference by having the Department of the Treasury issue new ___ _____________ _________________

US Treasury Securities

What is a built in stabilizer?

anything that increases the budget deficit during a recession, or anything that increases the budget surplus during a boom

Permanent change in taxes will ____________ taxes, ____________ income, and ______________ consumer spending

decrease, increase, increase

Temporary change in taxes will _____________ taxes, __________ income, and _______________ consumer spending

decrease, increase, increase

If C decreases, then real GDP ___________

decreases

If disposable income decreases by $x, then C ______________

decreases

If taxes increase by $x, then disposable income __________ by $x

decreases

How does a positive GDP gap, or economic boom, manipulate aggregate demand

decreases aggregate demand

non discretionary policy will automatically move the federal budget towards a ________________ during a recession and towards a __________________ during a boom

deficit, surplus

True or false: the public debt is the accumulation of household, business, and government debt over time

false; accumulation of federal budget deficits and surpluses over time

true or false: a budget deficit arises when the federal government expenditures are increasing

false; amount by which government expenditures exceed tax collections in a given year

True or false: fiscal policy refers to changing the level of government spend and taxes to achieve a greater equality in the distribution of income

false; change in level of government spending and taxes in order to stabilize the economy

True or false: a contractionary fiscal policy is designed to decrease short run aggregate supply

false; decrease aggregate demand

True or false: tax rates are an example of an automatic stabilizer

false; personal income tax, corporate income tax, ad payroll tax revenue

True or false: the primary objective of fiscal policy is to stabilize the size of the federal debt

false; stabilize the economy

what does the public debt consist of?

treasury bills, treasury notes, treasury bonds, and US savings bonds

if the government incurs a budget surplus, then the public debt will ________________

decrease

To get out of a boom what does Congress do?

decrease government spending, and increase taxes

Advantages of automatic stabilizers

1. they are built in, so dollar amounts change without action from Congress 2. no recognition lag and no administrative lag

Is public debt a burden to future generations?

1. it is a liability to taxpayers and an asset to the owners of government securities 2. if the debt is held internally, we would owe it to ourselves 3. if the debt is externally held, it would impact the economy negatively

Automatic stabilizers are

1. taxes/ revenues 2. unemployment compensation 3. welfare payments

How does contractionary fiscal policy effect the economy?

Aggregate demand decreases

How does expansionary fiscal policy effect the economy?

Aggregate demand increases

The economy is initially operating at its potential real GDP. Because of a deteriorating international political situation the federal government decides to increase military spending by $21 billion. At the same time policymakers decide to change the level of taxes to maintain full-employment, non-inflationary real GDP. Assume the MPC = 0.75 and the full multiplier effect is in effect. The level of taxes should be a. decreased by $28 billion. b. decreased by $15.75 billion. c. increased by $28 billion. d. increased by $21 billion.

C; 0.75 * x= 21 x=28

Assume the economy is at its full employment real GDP. which of the following would most likely result if the federal government increased spending without increasing tax revenues? A. decrease in potential real GDP B. decrease in the public debt C. an increase in the price level D. a recession

C; increase in the price level

During the past twelve months unemployment has been under 5%, and the GDP price index has increased by 2%. Total production of goods and services is projected to be 5% higher in the next twelve months. Which of the following policies would be most appropriate for short run stabilization purposes? A. increasing federal government spending B. decreasing federal income taxes C. passing new corporate tax incentives to encourage investment D. relying on the automatic stabilizers

D; relying on the automatic stabilizers

True or false: A large U.S. public debt cannot bankrupt the federal government, leaving it unable to meet its financial obligations, because the government can decrease interest rates which will increase investment spending

False; can meet obligations by refinancing maturing Treasury securities, increase taxes, and by creating money

True or false: the crowding out effect suggests that increases in consumption are usually at the expense of saving

False; crowding out of investment reduces aggregate demand and weakens fiscal policy

True or false: non- discretionary fiscal policy refers to congress changing the tax and transfer payments programs during a recession or inflationary boom to stabilize the size of government?

False; discretionary fiscal policy

True or false: a significant contributor to, or cause of, the large U.S. public debt is the financing of additional gross private domestic investment by businesses

False; wars, recession, and lack of fiscal discipline by congress cause a large public debt

Which is the most expansionary fiscal policy, a $10 billion increase in government spending or a $10 billion decrease in taxes?

Increase in government spending

formula to see how much C decreases

MPC* change in disposable income

Can the burden of war be shifted to future generations?

No. opportunity cost of the war is the forgone civilian goods and the lives lost

public debt

accumulation of federal budget deficits and surpluses over time

budget deficit

amount by which government spending exceeds tax collections in a given year

budget surplus

amount by which tax collections exceed government spending in a given year

The crowding out effect

an expansionary fiscal policy designed to increase aggregate demand, however the crowding out of investment reduces aggregate demand and weakens the impact of the expansionary fiscal policy

Certain government programs will ___________________ stabilize the economy

automatically

A wave of consumer and business optimism stimulates the economy. As a result GDP exceeds the economy's full-employment real GDP and the unemployment rate falls to 3%. The economic boom causes demand-pull inflation. In this situation proper counter-cyclical discretionary fiscal policy would involve: a. running a budget deficit. b. running a budget surplus. c. Congress increasing means-tested public assistance programs. d. Congress increasing tax revenues and government spending by the same amount.

b

Why is the economic impact of a $10 decrease in taxes smaller than the economic impact of a $10 increase in government spending?

because people will spend some of their savings, and save the rest

Crowding out of private investment is an economic _____________ to future generations

burden

Externally held debt is an economic _________ to Americans

burden

Objective of expansionary fiscal policy is to

close a recessionary gap by increasing aggregate demand

Objective of contractionary fiscal policy is to

close an inflationary gap by decreasing aggregate demand

Fiscal policy refers to

congress changing the levels of government spending and taxes to stabilize the economy

Discretionary fiscal policy

congress meets to change government expenses or taxes to close an output gap

Fiscal policy should be

counter-cycle

The greater the economy's built in stability, the larger __________ _____________ and _____________

cyclical deficits, surpluses

If the government incurs a budget deficit, then public debt will __________

increase

To get out of a recession what does Congress do?

increase government spending, and decrease taxes

Suppose the federal government had a budget deficit of $60 billion in year 1, a budget surplus of $20 billion in year 2, and a budget deficit of $90 billion in year 3. At the end of three years the federal government's public debt would have __________________ by $_______ billion

increase, $130

an expansionary fiscal policy is designed to ______________ aggregate _____________

increase, demand

How does a negative GDP gap, or recession, manipulate aggregate demand

increases aggregate demand

During an expansionary fiscal policy, what should congress do to the budget?

incur a budget deficit

During a contractionary fiscal policy, what should congress do to the budget?

incur a budget surplus

The less progressive the tax system, the ___________ __________ the economy

less stable

the ________________ __________________ the tax system, the _________ ___________ the economy

more progressive, more stable

Issue with fiscal policy in an open economy

net export effect arises , which weakens the impact of fiscal policy

Large public debt will ________ ______________________ the federal government

not bankrupt

If the government has a balanced budget, the the public debt will _________ _________

not change

The greater the economy's stability, the MPC becomes _______________, thus the multiplier becomes ______________

smaller, smaller

Operational lag

the time a policy action is taken and the time that the action has its effect on the economy

Administrative lag

time between recognition of the problem and the action taken to handle or solve it

Recognition lag

time lag between an actual economic shock occurs and when it is recognized by the government

Causes of a budget deficit and large public debt are

wars, recessions, and lack of fiscal discipline by Congress