ECO CH16
Select the answer below that best corrects the following statement: "An expansionary fiscal policy LOADING... involves an increase in government purchases or an increase in taxes."
An expansionary fiscal policy involves the increase of government purchases and/or a decrease in taxes in order to increase aggregate demand.
Suppose that at the same time Congress and the president pursue an expansionary fiscal policy, the Federal Reserve pursues an expansionary monetary policy. How might an expansionary monetary policy affect the extent of crowding out in the short run?
An expansionary monetary policy would decrease interest rates and thus reduce the extent of crowding out.
Are federal expenditures higher today than they were in 1960?
As a percentage of GDP, federal expenditures have increased since 1960.
Are federal purchases higher today than they were in 1960?
As a percentage of GDP, federal purchases have decreased since 1960.
Consider the same list of arguments about changing to a flat tax. Which two out of the above list of arguments would you advance against a flat tax?
B and C
Which of the following statements regarding the 2009 stimulus package is true?
The largest category of expenditures was health care, social services, and education; and the largest category of tax cuts was individual tax cuts.
Why does a $1 increase in government purchases lead to more than a $1 increase in income and spending?
Through the government purchases multiplier, the $1 increase in government spending will lead to an increase in aggregate demand and national income, which will lead to an increase in induced spending.
Why do few economists argue that it would be a good idea to balance the federal budget every year?
To keep a balanced budget during a recession, taxes would have to increase and government expenditures would have to decrease, which would further reduce aggregate demand and deepen the recession.
Use a dynamic aggregate demand and aggregate supply graph to illustrate the change in macroeconomic equilibrium from 2021 to 2022, assuming that the economy experiences deflation during 2022.
In order for deflation to take place in 2022, the economy does also have to be experiencing a recession.
b. What actions can the government take to bring real GDP to its potential level in 2019?
In order to bring real GDP to its potential level in 2019, the government can engage in expansionary fiscal policy by either increasing government spending or decreasing taxes.
Which can be changed more quickly: monetary policy or fiscal policy?
Monetary policy can be changed more quickly than fiscal policy. Monetary policy can be changed at any of the FOMC meetings and the smaller number of individuals involved makes it easier to change policy.
Suppose that the economy is currently at potential GDP, and the federal budget is balanced. If the economy moves into recession, what will happen to the federal budget?
If the budget is balanced at potential GDP and the economy moves into recession, then there will be a budget deficit as government expenditures increase and tax revenues decrease.
Which of the following statements about the federal debt is correct?
If the debt becomes very large relative to the economy, then the government may have to raise taxes to high levels or reduce other types of spending to make the interest payments on the debt.
If the marginal propensity to consume equals 0.60, the tax rate equals 0.20, and the marginal propensity to import equals 0.20, what is the value of the government purchases multiplier?
The government purchases multiplier is equal to 1.39 (enter your response rounded to two decimal places).
If the short-run aggregate supply curve (SRAS) were a horizontal line, what would be the impact on the size of the government purchases and tax multipliers LOADING...?
The impact of the multiplier would be larger if the SRAS curve is horizontal.
b. Why does an estimate of the size of the multiplier matter in evaluating the effects of an expansionary fiscal policy?
The larger the multiplier, the greater the effects of an expansionary fiscal policy.
The cyclically adjusted budget deficit
is measured as if the economy were at potential real GDP.
If a tax cut has supply-side effects, then
it will affect both aggregate demand and aggregate supply.
Keynes appears unconcerned if government spending is wasteful because
it will still lead to an increase in production and employment.
The federal government would not want to increase its spending, even if the result were to increase real GDP and employment in the short run, if
it would lead to a greater federal deficit and an increase in the national debt.
The federal government's day-to-day activities include running federal agencies like the Environmental Protection Agency, the FBI, the National Park Service, and the Immigration and Customs Enforcement. Spending on these types of activities make up
less than 10 percent of federal government expenditures.
As a result of crowding out LOADING... in the short run, the effect on real GDP of an increase in government spending is often
less than the increase in government spending
As a result of crowding out LOADING... in the short run, the effect on real GDP of an increase in government spending is often
less than the increase in government spending.
[Related to the Making the Connection] A report from the International Monetary Fund in late 2014 contained the following observations: "Five years after the global financial crisis, the economic recovery continues but remains weak. ... Given ... the current environment of low government borrowing costs ... might this be a good time to increase public infrastructure investment?" Source: International Monetary Fund, "World Economic Outlook: Legacies, Clouds, Uncertainties", October 2014, pp. 75-76. The reference to "low government borrowing costs" means that
low interest rates make borrowing less expensive.
According to the multiplier effect LOADING..., an initial decrease in government purchases decreases real GDP by more than the initial decrease in government purchases.
more than
"Real GDP is currently $17.7 trillion, and potential real GDP is $17.4 trillion. If Congress and the president would decrease government purchases by $300 billion or increase taxes by $300 billion, the economy could be brought to equilibrium at potential GDP." If government purchases were to decrease by $300 billion or if taxes were increased by $300 billion, the equilibrium level of real GDP would decrease by
more than $300 billion. Therefore, the statement above is incorrect .
The report also notes: "In advanced economies an increase in infrastructure investment ... is one of the few remaining policy levers available to support growth." When infrastructure investment is described as a "policy lever" it means that
because infrastructure investment adds to the productive capacity of the economy, policies that promote it can spur economic growth.
To reduce a budget deficit,
budgetary policies such as increasing taxes and cutting expenditures can be used.
The large budget deficits of $1.4 trillion in fiscal year 2009 and $1.3 trillion in fiscal year 2010 were
caused partly by the increase in government spending including spending to bail out failed financial institutions and by the deep decline in tax revenues as incomes and profits fell.
By repercussions, Keynes means that an initial increase in autonomous expenditures will
change production by an amount greater than the initial increase in autonomous expenditures.
b. Suppose that Congress and the president were committed to balancing the budget each year. How does what happened during 2013 provide insight into difficulties they might run into in trying to balance the budget every year. Because government spending and tax revenues
change with GDP, balancing the budget annually would result in economic disruptions.
The reference to "the environment in which they are implemented" is a recognition that
changes in government spending can be offset or reinforced by monetary policy, and that the impacts will be different at different phases of the business cycle.
A report from the Congressional Budget Office (CBO) notes, "Potential GDP is CBO's estimate of the maximum sustainable output of the economy." In early 2015, the CBO estimated that the gap between real GDP and potential GDP would fall from 2.9 percent in 2014 to zero in 2017. In 2014, real GDP was $16.3 trillion and the CBO's estimate of potential GDP was $16.8 trillion. The CBO forecast that potential GDP would increase to $17.5 trillion. Sources: Congressional Budget Office, "The 2015 Long-Term Budget Outlook," June 2015, p. 36; and Congressional Budget Office, "The Budget and Economic Outlook: 2015 to 2025," January 2015. The CBO includes the word "sustainable" in its definition of potential GDP because
given the available resources in the economy, this is level of GDP that can be maintained.
In the context of what was happening in the economy in 1929, President Hoover was _____ in saying that, in 1932, nothing was more necessary than balancing the federal government's budget.
incorrect
Between the beginning of 2009 and the end of 2010, real GDP ________, while employment ________.
increased by 4.0 percent; declined by 3.3 million
b. In terms of its effect on the long-run growth rate of real GDP, it is likely to matter more if the additional government spending involves
increased spending on highways and bridges.
Which of the following raises the largest percentage of federal government revenue?
individual income taxes
Low government borrowing costs would be relevant for the decision regarding whether a government increases infrastructure investment because
infrastructure investments are long-term and expensive investments that require the use of borrowed funds.
Due to the American Recovery and Reinvestment Act of 2009long dashthe stimulus packagelong dashthe effect on federal government
revenue and expenditures was highest in 2010 but both effects declined in 2011.
The recessions accompanied by a financial crisis are more severe than recessions that do not involve bank crises because
severe financial crises collapse asset markets, lower real housing prices and cause a significant fall in GDP and employment.
If current projections of federal spending on Social Security and Medicare are accurate, policymakers are faced with the choice of
significantly restraining spending on these programs and/or greatly increasing taxes on households and firms.
Suppose that the tax increase only affected aggregate demand. Compared to the above, the effect on real GDP would be smaller and the effect on the price level would be larger .
smaller larger
The Greek government responded to the recession by cutting its budget in contrast to the typical response, which is to
spend more. Historically high overspending had weakened its economy.
Policy that is specifically designed to affect aggregate supply and increase incentives to work, save, and start a business, by reducing the tax wedge LOADING... is called
supply-side economics.
As the tax rate increases,
the multiplier effect decreases.
The figure on the right refers to the dynamic AD-AS model. In that model, aggregate demand (AD), short-run aggregate supply (SRAS), and long-run aggregate supply (LRAS) all shift to the right in any given year (i.e., AD1 right arrow AD2 and LRAS1 right arrow LRAS2 ). Notice that the graph only shows the shifts in aggregate demand (AD) and long-run aggregate supply (LRAS); for purposes of this exercise we ignore short-run aggregate supply. Now suppose that there is an increase in marginal tax rates on individual income that affects both aggregate demand and long-run aggregate supply. Compared to the dynamic changes shown in the graph, the result of the increase in the marginal tax rate will be that
the rightward shift in aggregate demand will be smaller and the rightward shift in long-run aggregate supply will be smaller.
The largest and fastest-growing category of federal expenditures is
transfer payments.
The revenue the federal government collects from the individual income tax declines during a recession. This is an example of
an automatic stabilizer.
The total the federal government pays out for unemployment insurance decreases during an expansion. This is an example of
an automatic stabilizer.
The increase in the number of people age 65 or older will result in _____ in federal spending on Social Security and Medicare as a percentage of GDP.
an increase
The effect on the economy of tax reduction and simplification is
an increase in the quantity of real GDP supplied at every price level, and a shift in the long-run aggregate supply curve.
Changes in taxes and spending that happen without actions by the government are called
automatic stabilizers.
Two examples of automatic stabilizers in the U.S. are
unemployment insurance payments and the progressive income tax system.
Automatic stabilizers can reduce the severity of a recession because, during a recession,
unemployment payments rise and tax collections fall, providing more spending ability to push the economy back to full employment.
Holding other factors constant, by how much will taxes have to be cut to bring the economy to equilibrium at potential GDP?
Taxes will need to be cut by $ 100 billion.
Crowding out refers to
the decline in private expenditures that result from an increase in government purchases.
Similarly, explain why a decrease in the marginal propensity to import would increase the size of the government purchases multiplier. The value of the government purchases multiplier would decrease because in the formula for the multiplier the denominator is
1 minus [MPC times (1 minust) minus MPI]
a. If the government does not take any policy actions, then, in 2019, the value of real GDP will be $ 18.2 trillion and the value of the price level will be 117. (Enter your responses rounded to one decimal place.)
18.2;117
If the government's policy is successful, what is the effect of the policy on the following macroeconomic indicators?
Actual real GDP decreases . Potential real GDP does not change . Price level decreases . Unemployment increases .
If the federal government's policy is successful, what is the effect on the following macroeconomic indicators?
Actual real GDP: increases Potential real GDP: does not change Price level: increases Unemployment: decreases
Suppose a political candidate hired you to develop two arguments in favor of a flat tax. Consider the following list of arguments about changing to a flat tax: A. There would be a reduction in paperwork and the compliance cost of the tax system. B. The complexities in the current tax code allow the government to pursue other policy goals. C. A change in the tax code would result in a more unequal distribution of income because the marginal tax rate on high-income taxpayers would be reduced. D. There are potential increases in labor supply, savings, and investment from a lower marginal tax rate. Which two out of the above list of arguments would you advance in favor of a flat tax?
A and D
Select the answer below that best corrects the following statement: "A contractionary fiscal policy involves a decrease in government purchases or a decrease in taxes."
A contractionary fiscal policy involves the decrease of government purchases and/or an increase in taxes in order to decrease aggregate demand.
What is the "tax wedge"?
A tax wedge is the difference between the pretax and posttax return to an economic activity. For example, a tax on interest income would decrease the posttax return to investment.
A political commentator argues: "Congress and the president are more likely to enact an expansionary fiscal policy than a contractionary fiscal policy because expansionary policies are popular and contractionary policies are unpopular." Briefly explain whether you agree.
Agree because expansionary fiscal policies create employment and increase GDP whereas contractionary fiscal policies impose an artificial recession on the economy.
Which of the following is not a correct comparison between an expansionary fiscal policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?
All of the above are correct statements about the two models.
How does a budget deficit LOADING... act as an automatic stabilizer and reduce the severity of a recession?
All of the above.
Increased government debt can lead to higher interest rates and, as a result, crowding out of private investment spending. In terms of borrowing (debt-spending), what will offset the effect of crowding out in the long run so that government debt poses less of a problem to the economy?
All of the above.
What are the gains to be had from simplifying the tax code?
All of the above.
Which of the following are categories of federal government expenditures?
All of the above.
The following was written by a political columnist: "Today...the main purpose [of government's issuing bonds] is to let craven politicians launch projects they know the public, at the moment, would rather not fully finance. The tab for these projects will not come due, probably, until after the politicians have long since departed for greener (excuse the expression) pastures." Source: Paul Carpenter, "The Bond Issue Won't Be Repaid by Park Tolls," (Allentown, PA) Morning Call, May 26, 2002.
Borrowing is a bad idea to pay for current expenses but a good idea to pay for long-lived capital goods .
What is a contractionary fiscal policy?
Contractionary fiscal policy includes decreasing government spending and increasing taxes to decrease aggregate demand.
What is meant by crowding out?
Crowding out is a decline in private expenditures as a result of increases in government purchases.
Does judging whether a deficit is excessive depend in part on whether the country is in a recession?
During a recession, the deficit is higher as tax revenue falls and spending increases making an existing deficit even bigger.
In what ways does the federal budget serve as an automatic stabilizer for the economy?
During a recession, there is an increase in government expenditures for transfer payments and a decrease in taxes as wages and profits fall. During an expansion, there is a decrease in government expenditures for transfer payments and an increase in taxes as wages and profits rise. Both of these occur automatically and both effects help to stabilize aggregate demand.
Consider the figures below. Determine which combination of fiscal policies shifted AD 1 to AD 2 in each figure and returned the economy to long-run macroeconomic equilibrium.
Example (A): Expansionary fiscal policy. Example (B): Contractionary fiscal policy.
The figure to the right illustrates the dynamic AD-AS model LOADING.... Suppose the economy is in equilibrium in the first period at point (A). In the second period, the economy reaches point (B). We would expect the federal government to pursue what type of policy in order to move AD 2 to AD Subscript 2 comma policy and reach equilibrium (point C) in the second period?
Expansionary fiscal policy
What is an expansionary fiscal policy?
Expansionary fiscal policy includes increasing government spending and decreasing taxes to increase aggregate demand.
A simplified tax code would reduce economic efficiency by increasing the number of decisions households and firms make solely to reduce their tax payments.
False
Decreasing the tax rate decreases the value of the government purchases multiplier.
False
The higher the tax rate, the larger the multiplier effect.
False
What is the difference between federal purchases and federal expenditures?
Federal purchases require that the government receives a good or service in return, whereas federal expenditures include transfer payments.
What is fiscal policy?
Fiscal policy can be described as changes in government spending and taxes to achieve macroeconomic policy objectives.
What is the difference between federal government purchases (spending) and federal government expenditures?
Government purchases are included in government expenditures.
Suppose that real GDP is currently $13.6 trillion and potential real GDP is $14.0 trillion, or a gap of $400 billion. The government purchases multiplier LOADING... is 5.0, and the tax multiplier is 4.0. Holding other factors constant, by how much will government purchases need to be increased to bring the economy to equilibrium at potential GDP?
Government spending will need to be increased by $ 80 billion.
The hypothetical information in the following table shows what the situation will be in 2021 if the federal government does not use fiscal policy:
If Congress and the president want to keep real GDP at its potential level in 2021, they should use an expansionary fiscal policy , which would mean increasing government spending or cutting taxes .
The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model LOADING...
If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS 06, we would expect the federal government to pursue a(n) contractionary fiscal policy.
Which of the following best describes the difference between crowding out in the short run and in the long run?
In the short run, an increase in government purchases may not fully crowd out private expenditures due to the stimulative effect of an increase in government purchases on aggregate demand. In the long run, most economists believe that a permanent increase in government purchases will result in complete crowding out of private expenditures.
What changes should they make if they decide a contractionary fiscal policy is necessary?
In this case, Congress and the president should enact policies that decrease government spending and increase taxes.
If Congress and the president decide an expansionary fiscal policy is necessary, what changes should they make in government spending or taxes?
In this case, Congress and the president should enact policies that increase government spending and decrease taxes.
In The General Theory of Employment, Interest, and Money, John Maynard Keynes wrote this: "If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise...to dig the notes up again... there need be no more unemployment and, with the help of the repercussions, the real income of the community...would probably become a good deal greater than it is."
In this statement, Keynes is discussing the important macroeconomic effect called the multiplier effect.
The figure to the right illustrates the dynamic AD-AS model LOADING.... Suppose the economy is in equilibrium in the first period at point (A). In the second period, the economy reaches point (B). What policy would the federal government likely pursue in order to move AD 2 to AD Subscript 2 comma policy and reach equilibrium (point C) in the second period?
Increase government spending
The graph to the right shows a situation in which the economy was in equilibrium at potential GDP (at point A) when the demand for housing sharply declined. What actions can Congress and the president take to move the economy back to potential GDP?
Increase government spending or decrease taxes.
Consider the figure to the right. An increase in government spending shifted the aggregate demand curve from AD 1 to AD 2. As a result, both price level and real GDP increased. What can be said, however, about the increase in real GDP?
It increased by less than indicated by a multiplier with a constant price level.
Consider the figure to the right. What is the effect on LRAS if tax reductions and tax code simplifications are effective? The initial equilibrium can be point A, B, or C. Of the following choices, which shows the most effective tax code simplification?
It shifts from LRAS 1 to LRAS 3.
The federal government collected less in total individual income taxes in 1983 than in 1982. Can we conclude that Congress and the president cut individual income tax rates in 1983?
No. It could be that the economy contracted, so less income was earned and less was paid in tax.
After September 11, 2001, the federal government increased military spending on wars in Iraq and Afghanistan. Is this increase in spending considered fiscal policy?
No. The increase in defense spending after that date was designed to achieve homeland security objectives.
Which of the following is not a correct comparison between a contractionary fiscal policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?
None of the above are correct statements about the two models.
How important is it to pay off this debt?
Not very important if the debt is at a sustainable level, and the interest payments are relatively constant.
If Congress and the president are successful in keeping real GDP at its potential level in 2021, state whether each of the following will be higher, lower, or the same as it would have been if they had taken no action:
Real GDP will be higher . Potential real GDP will be the same . The inflation rate will be higher . The unemployment rate will be lower .
What is the cyclically adjusted budget deficit or surplus?
The cyclically adjusted budget deficit or surplus is the deficit or surplus in the federal government's budget if the economy were at potential GDP.
In 2015, an article in the Wall Street Journal noted that "Prime Minister Shinzo Abe is expected to unveil a plan to balance Japan's budget in five years ... as a step toward reducing the country's debt burden, according to government officials." Source: Tatsuo Ito, "Japan Government Takes On Its Deficit-Ridden Finances," Wall Street Journal, June 17, 2015. Which of the following statements is true?
The debt is accumulated deficits, so if there is a positive budget deficit, the debt will increase.
What is the long-run effect of a permanent increase in government spending?
The decline in investment, consumption, and net exports exactly offsets the increase in government spending; therefore, real GDP remains unchanged.
What is the difference between the federal budget deficit and federal government debt?
The federal budget deficit is the year-to-year short fall in tax revenues relative to government spending (T < G + TR), financed through government bonds. The federal government debt is the accumulation of all past deficits.
Who is responsible for fiscal policy?
The federal government controls fiscal policy.
Assuming a fixed amount of taxes and a closed economy and that the marginal propensity to consume equals 0.75, calculate the value of the following multipliers. Be sure to use a negative sign (-) to show if a multiplier has a negative value.
The government purchases multiplier equals 4.0 (enter your response rounded to one decimal place). The tax multiplier equals negative 3.0 (enter your response rounded to one decimal place). The balanced budget multiplier equals 1 (enter your response rounded to one decimal place).
Countries with a higher marginal propensity to import (MPI) will have smaller multipliers than countries with a lower marginal propensity to import.
True
Few economists believe the federal government should attempt to balance its budget every year.
True
The actual change in real GDP resulting from an increase in government purchases or a cut in taxes will be less than the simple multiplier effect indicates.
True
The balanced budget multiplier is always equal to 1.
True
When is it considered "good policy" for the government to run a budget deficit?
When borrowing is used for long-lived capital goods.
If the government cuts taxes in order to increase aggregate demand, the action is called
a discretionary fiscal policy
Congress and the president enact a temporary cut in payroll taxes. This is an example of
a discretionary fiscal policy.
In a column in the Financial Times, the prime minister and the finance minister of the Netherlands argue that the European Union, an organization of 27 countries in Europe, should have "a commissioner for budgetary discipline." They believe that: "The new commissioner should be given clear powers to set requirements for the budgetary policy of countries that run excessive deficits." Source: Mark Rutte and Jan Kees de Jager, "Expulsion from the Eurozone Has to Be the Final Penalty," Financial Times, September 7, 2011. An "excessive" budget deficit in this context is
a relatively large budget deficit as a percentage of GDP beyond the European Union's deficit and debt rules .
Identify each of the following as: (i) part of an expansionary fiscal policy, (ii) part of a contractionary fiscal policy, or (iii) not part of fiscal policy.
a. The corporate income tax rate is increased. This is part of a contractionary fiscal policy . b. Defense spending is increased. This is not part of fiscal policy . c. The Federal Reserve lowers the target for the federal funds rate. This is not part of fiscal policy . d. Families are allowed to deduct all their expenses for daycare from their federal income taxes. This is not part of fiscal policy . e. The individual income tax rate is decreased. This is part of an expansionary fiscal policy .
Some economists argue that because increases in government spending crowd out LOADING... private spending, increased government spending will reduce the long-run growth rate of real GDP.
a. This is most likely to happen if the private spending being crowded out is investment spending .
President Trump was assuming that in 2017, the economy was
able to create more jobs and expand without increasing the inflation rate.
According to a 2017 Congressional Budget Office (CBO) report, "By 2047, 22 percent of the population will be age 65 or older, CBO anticipates, compared with 15 percent today." Source: Congressional Budget Office, "The 2017 Long-Term Budget Outlook," March 2017, p. 7. The over-65 population is increasing so rapidly because
after WWII, there was a "baby boom," but after 1965 birthrates fell.
One-time tax rebates, such as those in 2001 and 2008, increase consumption spending by less than a permanent tax cut because one-time tax rebates increase
current income.
Complete the following table for a static AD-AS model:
decrease taxes rise Decrease gov't spending fall
The following is from a message by President Hoover to Congress, dated May 5, 1932: "I need not recount that the revenues of the Government as estimated for the next fiscal year show a decrease of about $1,700,000,000 below the fiscal year 1929, and inexorably require a broader basis of taxation and a drastic reduction of expenditures in order to balance the Budget. Nothing is more necessary at this time than balancing the Budget." According to the statement, balancing the Budget would require
decreasing government purchases and increasing taxes.
Economist Mark Thoma has written, "One of the difficulties in using fiscal policy to combat recessions is getting Congress to agree on what measures to implement. ... Automatic stabilizers bypass this difficulty by doing exactly what their name implies." Source: Mark Thoma, "The Importance of Automatic Stabilizers to the Economy," cbsnews.com, January 25, 2010. Automatic stabilizers are
government spending and taxes that automatically increase or decrease along with the business cycle.
Due to the American Recovery and Reinvestment Act of 2009 (the stimulus package), from 2009 through 2011, the federal budget deficit was
greater than 8 percent of GDP but fell to less than 3 percent of GDP in 2015.
What does Feldstein mean by a "behavioral response" to tax cuts? The behavioral response will be that people in
higher tax brackets will experience an increase in taxable income and thus will work more.
Wall Street Journal writers Josh Zumbrun and Nick Timiraos published answers to several of their readers' questions regarding the federal government's debt. Two of the questions were: "Why is government debt different from mine?" and "How important is it to pay off this debt?" Source: Josh Zumbrun and Nick Timiraos, "Q&A: What the $18 Trillion National Debt Means for the U.S. Economy," Wall Street Journal, February 1, 2015. Government debt is different from household debt because
households cannot tax to bring in revenue and so will default if they can't make the payments.
The type of policy matters for the size of the multiplier because
households may not spend all of the saved taxes when there is a tax cut, but an increase in government spending will increase aggregate demand by the full amount.
According to a study by Kanishka Misra of the University of Michigan and Paolo Surico of the London Business School, "Almost half of American families did not adjust their consumption following receipt of the ... 2008 tax rebate." Source: Kanishka Misra and Paolo Surico, "Consumption, Income Changes, and Heterogeneity: Evidence from Two Fiscal Stimulus Programs," American Economic Journal: Macroeconomics, Vol. 6, No. 4, October 2014, pp. 84-106. In general, we expect that people will increase their consumption
if their disposable income increases.
As a result, when compared to Y1, real GDP would
increase
An article in the Wall Street Journal in 2015 noted that an official of the European Union was forecasting that "Greece faces two years of recession amid sharp budget cuts." Source: Gabriele Steinhauser and Andrea Thomas, "Greece Faces Two-Year Recession amid Bailout Cuts," Wall Street Journal, August 12, 2015. During a recession, a government's budget deficit will
increase as there are more government expenditures for income support programs and less tax revenue as income falls.
Compared to P1, the price level would
increase if aggregate demand increased more than long-run aggregate supply.
Writing in the Wall Street Journal, Martin Feldstein, an economist at Harvard University, argues that: "behavioral responses" of taxpayers to the cuts in marginal tax rates enacted in 1986 resulted in "an enormous rise in the taxes paid, particularly by those who experienced the greatest reductions in marginal tax rates." Source: Martin Feldstein, "The Tax Reform Evidence from 1986," Wall Street Journal, October 24, 2011. Cuts in marginal tax rates will
increase marginal net-of-tax income, increase the supply of labor and increase total taxes as people work longer hours.
Briefly explain whether each of the following is an example of (1) a discretionary fiscal policy, (2) an automatic stabilizer, or (3) not a fiscal policy. The federal government increases spending on rebuilding the New Jersey shore following a hurricane. This is an example of
not a fiscal policy.
The Federal Reserve sells Treasury securities. This is an example of
not a fiscal policy.
The federal government changes the required gasoline mileage for new cars. This is an example of
not a fiscal policy.
The 2008 tax cut made it more likely that people would not respond by increasing their consumption spending because it was a
one-time tax cut that affected current, not permanent, income.
Economists use the term fiscal policy to refer to changes in taxing and spending policies
only by the federal government.
Economists believe that the smaller the tax wedge for any economic activity, such as working, saving, investing, or starting a business,
the more of that economic activity that will occur.
In February 2013, the Congressional Budget Office (CBO) forecast that the federal budget deficit for fiscal year 2013 would be approximately $850 billion. In May 2013, the CBO revised down its forecast of the budget deficit to $642 billion. The CBO stated that a major reason for the downward revision was "factors related mainly to the strengthening economy." Source: Susan Davis, "CBO Drops 2013 Deficit Estimate to $642 Billion," usatoday.com, May 15, 2013. a. A "strengthening economy" could lead to a downward revision of the projected budget deficit because as GDP increases,
tax revenues increase and government spending decreases, lowering the deficit.
There may be some truth in the columnist's argument, but an economist might argue that
taxpayers in one year should not have to pay for a project that will benefit other taxpayers well into the future.
From an understanding of the multiplier process, explain why an increase in the tax rate would decrease the size of the government purchases multiplier. The value of the government purchases multiplier would decrease because in the formula for the multiplier
the MPC is multiplied by (1 minus t).
The debt is a "burden" on
the current generation, which pays the interest on the debt, and future generations, which will be taxed to pay for present spending.
In 2017, in proposing a $1 trillion increase in government spending on infrastructure, President Trump argued that the spending would increase total employment in the United States. Source: Ted Mann and Michael C. Bender, "President Trump to Launch Push for Infrastructure Investment," Wall Street Journal, June 4, 2017. In the short run, increases in federal spending will increase real GDP and employment if
the economy is producing at less than its potential output and has some cyclical unemployment.
The size of the multiplier could be affected by how close real GDP is to potential GDP because
the effects are more positive during recessions than during inflations.
Another infrastructure project in northern California funded in part by ARRA funds involved expanding the Caldecott Tunnel between the cities of Oakland and Orinda. Source: Zusha Elinson, "Caldecott Tunnel Edges Forward, Tribute to Stimulus Bill," New York Times, September 10, 2011. A spokesperson for the California state agency in charge of the project mentioned that the Caldecott tunnel project would have a "ripple effect" on employment. The ripple effect meant that
the job creation would spread to other industries and eventually to the whole economy due to the consumption of the construction workers.
We saw that in calculating the stimulus package's effect on real GDP, economists in the Obama administration estimated that the government purchases multiplier has a value of 1.57. John F. Cogan, Tobias Cwik, John B. Taylor, and Volker Wieland, in a research paper written in early 2009, argue that the value is only 0.61. Source: John F. Cogan, Tobias Cwik, John B. Taylor, and Volker Wieland, "New Keynesian versus Old Keynesian Government Spending Multipliers," National Bureau of Economic Research Working Paper No. 14782, March 2009. a. The government purchases multiplier can have a value greater than zero and less than 1 if
the marginal propensity to consume is negative.
It would seem that both households and businesses would benefit if the federal income tax were simpler and tax forms were easier to fill out. However, tax laws have become increasingly complicated because
the tax laws are used to encourage certain activities and discourage others.
A Federal Reserve publication argues that the size of the multiplier "depends on the type of fiscal policy changes in question and the environment in which they are implemented." Source: Daniel J. Wilson, "Government Spending: An Economic Boost?," Federal Reserve Bank of San Francisco Economic Letter, February 6, 2012. In referring to "the type of fiscal policy changes in question," the author recognizes that
the tax multiplier is different from the government purchases multiplier.
The national debt is best measured as
the total value of U.S. Treasury securities outstanding.
In 2015, the ratio of imports to GDP was 18 percent in Japan and 81 percent in Belgium. On the basis of this information, you can conclude that
the open-economy multiplier in Belgium would be less than the the open-economy multiplier in Japan.
The goal of expansionary fiscal policy is
to increase aggregate demand.
What is meant by supply-side economics?
Supply-side economics refers to the use of taxes to increase incentives to work, save, invest, and start a business in order to increase long-run aggregate supply.
Is it possible for Congress and the president to carry out an expansionary fiscal policy if the money supply does not increase?
Yes, because fiscal policy and monetary policy are separate things.
In 2009, Congress and the president enacted "cash for clunkers" legislation that paid people buying new cars up to $4,500 if they traded in an older, low gas-mileage car. Source: Justin Lahart, Trade-In Program Tunes Up Economic Engine," Wall Street Journal, August 4, 2009. Was this piece of legislation an example of fiscal policy?
Yes, because the primary goal of the spending program was to stimulate the national economy.
Does government spending ever reduce private spending?
Yes, due to crowding out.
An attempt to reduce inflation requires _____________ fiscal policy, which causes real GDP to _________ and the price level to __________.
contractionary; fall; fall
According to the crowding-out effect, if the federal government increases spending, the demand for money and the equilibrium interest rate will ___________, which will cause consumption, investment, and net exports to ___________.
increase; decrease
Budget deficits automatically __________ during recessions and __________ during expansions.
increase; decrease
Over time, potential GDP ________, which is shown by the ________ curve shifting to the right.
increases; long-run aggregate supply
Expansionary fiscal policy has a ________ multiplier effect on equilibrium real GDP, and contractionary fiscal policy has a ________ multiplier effect on equilibrium real GDP.
positive; negative
Since World War II, the federal government's share of total government expenditures has been between
two-thirds and three-quarters.
About ________ of the American Recovery and Reinvestment Act stimulus package took the form of increases in government expenditures, and about ________ took the form of tax cuts.
two-thirds; one-third
