Macro: Ch 31- Fiscal Policy, Deficits, and Debt

Use the aggregate expenditures model to show how government fiscal policy could eliminate either a recessionary expenditure gap or an inflationary expenditure gap. Given that full employment exists at $5,000, does a recessionary gap or inflationary gap exist? _______ Identify this gap in the diagram below. What is the dollar amount of this expenditure gap? $___

#3 ???

List in order the steps for government to follow in order to correct an inflationary gap without throwing it into a recessionary gap?

1. Take into account the size of the inflationary GDP gap 2. Know that the price level is fixed and the aggregate supply curve is horizontal so the multiplier is in full effect 3. Calculate the effect of the multiplier 4. After applying the multiplier, initiate a change in government spending that accounts for the entire inflationary gap.

cyclical deficit

A by-product of the economy's slide into recession, not the result of discretionary fiscal actions by the government.

Council of Economic Advisers (CEA)

A group of three economists appointed by the president to provide expertise and assistance on economic matters.

What type of tax system would have the most built-in stability?

A progressive tax because it increases at an increasing rate as incomes rise, thus having more of a dampening effect on rising (or falling) incomes.

Discretionary fiscal policy consists of deliberate changes in government spending and taxation designed to do which of the following?

Achieve full employment; Control inflation; Encourage economic growth.

c. A sudden recession is recognized by politicians, but it takes many months of political deal making before a stimulus bill is finally approved.

Administrative lag

crowding-out effect

An expansionary fiscal policy (deficit spending) may increase the interest rate and reduce investment spending , thereby weakening or canceling the stimulus of the expansionary policy.

built-in stabilizer

Anything that increases the government's budget deficit (or reduced its budget surplus) during a recession and increases its budget surplus (or reduces its budget deficit) during an expansion without requiring explicit action by policymakers.

regressive tax system

Average tax rate falls as GDP rises

proportional tax system

Average tax rate remains constant as GDP rises

progressive tax system

Average tax rate rises with GDP (Average tax rate = tax revenue / GDP)

Suppose the full-employment, noninflationary level of real output is GDP3 (not GDP2) in the economy depicted in the figure below (Figure 31.3, p 689). If the economy is operating at GDP2 instead of GDP3, the current fiscal policy is To move the economy to full-employment, government should

Contractionary since a surplus would exist. Cut taxes or increase spending.

What provides the information needed to assess discretionary policy and determine whether it is expansionary, contractionary, or neutral?

Cyclically adjusted budgets

fiscal policy

Deliberate changes by Congress in government spending and taxes. Initiated by President, on advice of the Council of Economic Advisers (CEA). Designed to achieve full employment, control inflation, and encourage economic growth.

_______ fiscal policy changes do not occur automatically, but rather are made at the option of the Federal government.

Discretionary

U.S. government securities

Financial instruments issued by the federal government to borrow money to finance expenditures that exceed tax revenues.

public investments

Government expenditures on public capital (such as roads, highways, bridges, mass-transit systems, and electric power facilities) and on human capital (such as education, training, and health).

budget deficit

Government spending in excess of tax revenues.

Taxes restrain economic expansion because the reduce what?

Household and business spending

All else equal, which of the following are potentially crowded out as a result of expansionary fiscal policy?

Interest sensitive consumption; Investment

Match the following scenarios in which there are problems enacting and applying fiscal policy with the correct type of problem. a. To fight a recession, Congress has passed a bill to increase infrastructure spending—but the legally required environmental-impact statement for each new project will take at least two years to complete before any building can begin.

Operational lag

d. To fight a recession, the president issues an executive order requiring Federal agencies to get rid of petty regulations that burden private businesses—but the Federal agencies begin by spending a year developing a set of regulations on how to remove petty regulations.

Operational lag

Which of the following problems of timing may arise in connection with fiscal policy.

Operational lags; administrative lags, recognition lags

b. Distracted by a war that is going badly, inflation reaches 8 percent before politicians take notice.

Recognition lag

Historically, which of the following are reasons that a large US public debt might not threaten to bankrupt the Federal government?

Refinancing; Taxation

political business cycle

Swings in overall economic and real GDP resulting from election-motivated fiscal policy, rather than from inherent instability in the private sector.

Which of the following were part of the American Recovery and Reinvestment act?

Tax rebates for low and middle income earners; Increases in expenditures on infrastructure, and education

budget surplus

Tax revenues in excess of government spending

Which of the following explains why the amount of consumption will rise by $5 billion, and saving by $1.67 billion, if the government cuts taxes by $6.67 billion?

The MPC is 0.75; The MPS is 0.25 (MPC + MPS = 1. If MPC is 0.75, MPS must by 0.25.)

public debt

The U.S. national debt. The accumulation of years of federal deficits and surpluses.

Suppose that last year, the economy was in a recession, government spending was $595 billion and government revenue was $505 billion. Economists estimate that if the economy had been at its full-employment level of GDP last year, government spending would have been $555 billion and government revenue would have been $550 billion. Which of the following statements about this government's fiscal situation are true?

The government has a non-cyclically adjusted budget deficit of $90 billion. The government has a cyclically adjusted budget deficit of $5 billion.

How do state and local government respond during prosperity and recession?

The increase expenditures during prosperity and cut them during recession.

external public debt

The portion of public debt owed to foreign citizens, firms, and institutions.

When there is a ratchet effect, what happens to the price level when the aggregate demand (AD) declines?

The price level remains the same

In January, the interest rate is 5 percent and firms borrow $50 billion per month for investment projects. In February, the Federal government doubles its monthly borrowing from $25 billion to $50 billion. That drives the interest rate up to 7 percent. As a result, firms cut back their borrowing to only $30 billion per month. Which of the following is true?

There is a crowding-out effect of $20 billion.

Which of the following are types of US securities?

Treasury notes; US savings bonds; Treasury bonds; Treasury bills

Which of the following are fiscal tools that government may use to eliminate an inflationary GDP gap?

Use a combination of both decreased government spending and raised taxes; Raise taxes; Decrease government spending

expansionary fiscal policy

Use during a recession - AD too low, need to increase AD therefore: Increase government spending, decrease taxes, or a combination of both. Designed to increase aggregate demand and therefore raise real GDP.

contractionary fiscal policy

Use during demand-pull inflation, AD too high need to decrease AD therefore: Decrease government spending, increase taxes, or a combination of both.

cyclically adjusted budget

Used by economists to adjust actual federal budget deficits and surpluses to account for the changes in tax revenues that happen automatically whenever GDP changes.

For a person who thinks the public sector is too large, the fiscal options for ending severe demand-pull inflation would include a cut in prices. an increase in the interest rate. a cut in government spending. an increase in taxes.

a cut in government spending.

The key long-run problem of both Social Security and Medicare is the

aging, and the age distribution, of the U.S. population

If the economy starts out with a balanced Federal budget, a subsequent expansionary fiscal policy will create a _______.

budget deficit

Expectations of a near-term policy reversal weaken fiscal policy because

consumers may hesitate to increase their spending because they believe that tax rates will rise again.

Government can use tax increases to reduce _______ spending.

consumption

There is a(n) _______ relationship between US net tax revenues and GDP.

direct

The manipulation of taxes and federal spending in order to stimulate the economy or reduce inflation is known as expansionary or contractionary _______ policy.

fiscal

Which of the following are the main reasons that deficits have emerged?

fiscal policy; war financing, recessions

Payment to foreign holders of US _______ is an external public debt.

government bonds

Refinancing of the public debt might cause

higher interest rates that can lower investment and economic growth.

Virtually any tax will yield _______ tax revenue as GDP rises.

increasing

Which are included in the definition of "public" in regards to the holders of federal debt?

local governments; state governments

Social Security and Medicare are "pay-as-you-go" plans. This means that

most of the current revenues from the Social Security tax are paid to current Social Security retirees.

The _______ process magnifies the initial change in spending into successive rounds of new consumption spending.

multiplier

Paying off an internally held debt would

not burden the economy as a whole.

The enactment of discretionary fiscal policy may be slowed because it is conducted in a _______ arena.

political

A political business cycle is the concept that

politicians are more interested in reelection than in stabilizing the economy.

An economy's _______ output is also known as full-employment output.

potential

The total amount of money owed by the United States Treasury to holders of US securities is the total:

public debt

Which of the following would help a government reduce an inflationary output gap?

raising taxes and decreasing government spending

The _______ effect for inflation is an increase in the price level due to increases in aggregate demand, but when demand decreases, product prices, wage rates, and per-unit production cots are inflexible downward.

ratchet

Consumers who believe a tax increase is only temporary may _______ their saving to pay the tax while maintaining their consumption level.

reduce

The government's fiscal policy options for ending severe demand-pull inflation include reducing government spending, increasing taxes, or both. increasing interest rates, reducing government spending, or both. reducing government spending, increasing interest rates, or both. increasing taxes, raising interest rates, or both.

reducing government spending, increasing taxes, or both.

To positively stimulate the economy using fiscal policy, government spending should _______, and taxes should _______, or both.

rise; fall

Refinancing the public debt means

selling new bonds to retire maturing bonds.

Built-in, or automatic, stabilizers work by changing ______ so that GDP changes are reduced. government payouts and interest rates taxes and government payouts interest rates and investment wages and prices

taxes and government payouts

The distinction between the absolute and relative sizes of the public debt is important because

the absolute size doesn't tell you about an economy's capacity to repay the debt.

If the annual interest payments on the debt sharply increased as a percentage of the GDP,

the government would have to use tax revenues or go deeper into debt.

A recession results in a negative GDP gap and increases in _______ will always accompany this gap.

unemployment