CH. 18
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
Which of the following are categories of federal government expenditures?
All of the above.
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
Select the answer below that best corrects the following statement: "An expansionary fiscal policyLOADING... 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.
What is meant by crowding out?
Crowding out is a decline in private expenditures as a result of increases in government purchases.
(ii) The unemployment rate
Decrease the unemployment rate by increasing production.
Actual real GDP
Decreases
Price Level
Decreases
Consider the figures below. Determine which combination of fiscal policies shifted AD1 to AD2 in each figure and returned the economy to long-run macroeconomic equilibrium.
Example (A): Expansionary fiscal policy. Example (B): Contractionary fiscal policy.
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.
Use the graph to answer the following questions:
If the government does not take any policy actions, then, in 2021, the value of real GDP will be $18.3 trillion and the value of the price level will be 123.
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.
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.
Briefly explain whether an expansionary fiscal policy will cause each of the following variables to increase or decrease: (i) Real GDP
Increase real GDP by increasing aggregate demand.
(iii) The price level
Increase the price level because more is demanded.
Unemployment
Increases
Consider the figure to the right. An increase in government spending shifted the aggregate demand curve from AD1 to AD2. 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.
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.
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.
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
Who is responsible for fiscal policy?
The federal government controls fiscal policy.
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
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.
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.
U.S. federal government expenditures are comprised of purchases of goods and services (defense spending plus spending on all day-to-day activities), transfer payments, interest payments, and grants to state and local governments. Which of the following statements is true?
Transfer payments are the largest component of the federal budget (about 50%) followed by defense spending (about 20%), while spending on all its day-to-day activities is the smallest component (about 8%).
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
Congress and the president enact a temporary cut in payroll taxes. This is an example of
a discretionary fiscal policy.
If the government cuts taxes in order to increase aggregate demand, the action is called
a discretionary fiscal policy.
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.
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.
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.
Changes in taxes and spending that happen without actions by the government are called
automatic stabilizers.
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
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
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.
If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS06, we would expect the federal government to pursue a(n) contractionary fiscal policy.
contractionary
An attempt to reduce inflation requires _____________ fiscal policy, which causes real GDP to _________ and the price level to __________.
contractionary; fall; fall
Potential real GDP
does not change
The higher the tax rate, the larger the multiplier effect.
false
A report from the Congressional Budget Office (CBO) noted, "Real potential GDP is the maximum sustainable output of the economy adjusted to remove the effects of inflation." In early 2017, the CBO estimated that the gap between real GDP and potential GDP would fall from 1.1 percent in 2016 to 0.3 in 2018. In 2016, real GDP was $16.7 trillion, and the CBO's estimate of potential GDP was $16.9 trillion. The CBO forecast that potential GDP would increase to $17.4 trillion in 2018. Sources: Congressional Budget Office, "The 2017 Long-Term Budget Outlook," March 2017, p. 9; and Congressional Budget Office, "The Budget and EconomicOutlook: 2017 to 2027," January 24, 2017. 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.
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.
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
The inflation rate will be
higher
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.
Therefore, the statement above is
incorrect
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.
The U.S. federal government raises revenue from individual and corporate income taxes, social insurance taxes, and other sources (including excise taxes, tariffs, and payments to cut timber on federal lands). The largest share of federal revenues comes from
individual income taxes (about 44%), followed by social insurance taxes (about 35%) and corporate income taxes (about 13%).
ome economists argue that because increases in government spending crowd outLOADING... 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
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 ProtectionAgency, 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 outLOADING... in the short run, the effect on real GDP of an increase in government spending is often
less than the increase in government spending.
The unemployment rate will be
lower
Consider the following statement: "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.
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 ▼ incomemultipliermoney illusion effect.
multiplier
Briefly explain whether each of the following is an example of (1) a discretionary fiscal policy, (2) an automaticstabilizer, 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.
Economists use the term fiscal policy to refer to changes in taxing and spending policies
only by the federal government.
Due to the American Recovery and Reinvestment Act of 2009—the stimulus package—the 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.
Crowding out refers to
the decline in private expenditures that result from an increase in government purchases.
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
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.
As the tax rate increases,
the multiplier effect decreases.
Potential real GDP will be
the same
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 goal of expansionary fiscal policy is
to increase aggregate demand.
The largest and fastest-growing category of federal expenditures is
transfer payments.
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.
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.
Over time, potential GDP ________, which is shown by the ________ curve shifting to the right.
increases; long-run aggregate supply
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.
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.
