fiscal policy and crowding out

Suppose a country suffers from a recession. Identify the components of countercyclical fiscal policy reflected in the following examples. 1. The country introduces a tax cut of 4 percentage points to reduce economic hardship. 2. More people in the country now claim unemployment insurance from the government.

1. discretionary 2. automatic

Two economists estimate the government expenditure multiplier and come up with different results. One estimates the multiplier at 0.75, while the other comes up with an estimate of 1.2. Explain why these estimates are different in terms of the assumptions that each economist is making.

Compared to the first​ economist, the second economist must be assuming either a larger induced increase in​ consumption, a smaller crowding out​ effect, or both.

How can expansionary​ expenditure-based fiscal policy lead to crowding out in the​ economy?

Expenditure-based fiscal policy leads to more government​ borrowing, absorbing funds that would have otherwise been borrowed and expended by the private sector.

In his book The Optimum Quantity of Money​, Milton Friedman talks about a helicopter dropping​ $2,000 over a community. The cash dropped by the helicopter gives the people in this community more money to spend. A tax cut also has the same​ effect: it increases disposable income. Suppose tax​ cuts, analogous to the helicopter​ drop, were proposed as a method to shift the labor demand curve to the right following a recession. How effective do you think this policy would​ be?

Somewhat​ effective, but only to the extent that most of the tax cut is concurrently spent on domestic​ output, that multiplier effects​ occur, and crowding out is small.

What are the automatic and discretionary components of fiscal​ policy?

The automatic components do not require deliberate action on the part of the​ government, while the discretionary components do.

If a country implements a countercyclical fiscal​ policy, the budget deficit is likely to ______ during a recession. If the government borrows money to pay its​ bills, ________ taxpayers are implicitly responsible for paying back the​ government's debts.

rise future

Assume a government expenditure multiplier of 1.2. Fiscal policy could theoretically fix a recessionary output gap of ​$800.4 billion with a​ ____________.

​$667 billion increase in government spending.

If the current value of GDP is ​$15.18 trillion and the government is planning to increase spending by ​$600 billion​ (all in one​ year), the percentage increase in GDP using the multiplier estimate of the first economist is _____ percent. ​(Round your response to two decimal places​.) Using the multiplier estimate of the second economist and the same current value of​ GDP, the percentage increase in GDP is __________ percent. ​(Round your response to two decimal places​.)

2.96 4.74

How do expansionary policies differ from contractionary​ policies?

A. Expansionary policies seek to reduce the severity of​ recessions, while contractionary policies seek to slow down the economy when it grows too fast. B. Expansionary policies seek to shift the labor demand curve to the​ right, while contractionary policies seek to shift it to the left. C. Expansionary policies seek to increase economic growth and increase​ employment, while contractionary policies seek to reduce the risk of excessive price inflation. D. ALL OF THE ABOVE

The purpose of countercyclical policy is to​ ____________.

A. reduce the intensity of economic fluctations C. smooth the growth rates of employment, GDP, and prices. (A and C are correct.)

Which of the following statements are true if the government expenditure multiplier is​ zero? ​(Check all that apply.​)

C. This implies that private investment is fully​ 'crowded out' by government borrowing. D. Many economists believe this multiplier is close to zero when the economy is already booming.

Changing corporate tax rates is an example of countercyclical _________ policy. If the government lowers corporate tax​ rates, its goal would be a ___________ shift of the _________ curve.

fiscal, rightward, labor demand

Recession impacts employment less severely when wages exhibit downward __________

flexibility

Crowding out occurs when ______________ borrowing displaces __________ borrowing. Since expansionary fiscal policy should only take place during times of ________, it seems worth the risk for many policy makers.

government, private, recession