Chapter 16

What are the two types of fiscal policy?

Expansionary fiscal policy and contractionary fiscal policy

In the dynamic AD-AS model, what should the government do if current real GDP is below potential GDP? What if it is above potential GDP?

If the economy is operating below potential GDP, expansionary fiscal policy should be used to decrease unemployment. If the economy is operating above potential GDP, contractionary fiscal policy should be used to reduce inflation

How does the government enact these two types of fiscal policy?

In order to enact expansionary fiscal policy, the government must either increase government spending or decrease taxes. Contractionary fiscal policy requires the government to decrease government spending or increase taxes.

Why might the lag between deciding on a fiscal policy and enacting it have a negative effect on the economy?

Since it takes time for politicians to pass legislation that enacts fiscal policy, by the time they decide on an action, the economy may already be in a another state that makes fiscal policy harmful instead of helpful. As an ex, if the economy is in a recession, the gvo may decide to enact expansionary fiscal policy, However, by the time the government gets a bill passes that enacts that policy, the economy may have already moved on to an expansionary policy. Applying an expansionary fiscal policy when the economy is in an expansion may make the price level even higher than it would be otherwise, making inflation worse

What is the difference between the government budget deficit and government debt?

The gov deficit is the difference between gov spending and gov revenue for one year (this is usually called a fiscal year, which typically starts on the first day of oct). The gov debt is the sum of all gov deficits over its entire existence

What is crowding out? Is there complete crowding out in the short-run? What about the long-run?

Crowding out is the idea that an increase in government spending will decrease the amount of private expenditures. There is only partial crowding out in the short-run, but complete crowding out in the long-run

Why is maintaining a balanced budget a bad idea? Consider expansion and recession scenarios.

During expansion, gov tax revenue will increase adn gov spending, due to automatic stabilizers, will decrease. In order to maintain a balanced budget, taxes must be reduced and gov spending increase. This is expansionary fiscal policy, which is a bad idea during an expansion, making inflation worse. During recession, gov tax revenue will decrease and gov spending, due to automatic stabilizers, will increase. In order to maintain a balanced budget, taxes must be increased and gov spending reduced. This is contractionary fiscal policy, which is a bad idea during a recession, making unemployment grow even larger.

In the static AD-AS model, what should government do during an expansion? What about during recession?

Expansionary fiscal policy should be used during recession, contractionary fiscal policy should be used during expansion

Why might tax simplification result in economic growth?

Firms must devote resources to properly file their taxes with the government (often LOTS of resources). Simplifying the tax code allows firms to devote those resources into more productive endeavors, like increasing investment

How can fiscal policy encourage economic growth? What is the primary variable that government can change?

Fiscal policy can encourage economic growth b changing households' and firms' labor and investment behavior. This can be done primarily through reducing marginal tax rates to encourage households to provide more labor or firms to increase investment which increases the capital stock

How do we determine if something is fiscal policy?

Fiscal policy must satisfy three basic requirements: 1. it must be at the federal level, not state or local, 2. it cannot be an automatic stabilizer, it must be discretionary, 3. the purpose of the change in spending or taxes must be to shift AD For ex.,an increase in military spending to fund a war satisfies requirements 1 and 2, but fails to satisfy requirement 3

Is government debt always bad? If not, when can it become a problem?

Government debt is really only bad for an economy so long as taxes don't need to be increased to service the debt (pay off interest on the debt)

What is the equation for the tax multiplier? What is its sign (positive or negative)? Do the changes in tax revenue and real GDP have a positive or negative relationship?

tax multiplier= change in real GDP/ change in tax revenue The tax multiplier will be negative. There is a negative relationship between the change in real GDP and the change in tax revenue. This means that if tax revenue increase, real GDP will decrease and vice versa.

What is the difference between automatic stabilizers and discretionary fiscal policy?

An automatic stabilizer is government spending that changed with the state of the economy (ex. expansion or recession) and does NOT require government action. Discretionary fiscal policy is a change in government spending or federal taxed that requires government action

What is the equation for the government purchases multiplier? What is its sign (positive or negative)? Do the changes in autonomous expenditures and real GDP have a positive or negative relationship?

government purchases multiplier= change in real GDP/ change in autonomous expenditure. The sign of the government purchases multiplier is positive. That is, if autonomous expenditure increases, then real GDP will also increase. And vice versa.