Econ exam #4

Gross federal debt was greater than ​$16 trillion at the end of the 2012.​ Currently, interest rates are very​ low, but​ historically, interest rates on Treasury bonds have been considerably higher.​ Assume, for​ simplicity, that the government pays the same interest rate on all outstanding debt. If the interest rate is 4.8​%, the approximate annual interest payment is ​$______ trillion.

0.77

The dollar value of the U.S. public debt is the highest in U.S. history and the​ highest, in absolute​ terms, in the world. Is this fact a reason to be concerned about the​ debt?

C. ​No, because the​ debt-to-GDP ratio for the United States is smaller than many other countries.

What effect did the CBO forecast that automatic stabilizers would have on the​ economy?

Since the contribution of automatic stabilizers to the budget​ deficit, measured as a share of potential​ GDP, are forecast to be​ 2.7%, they are expected to provide a boost to the economy.

Some economists are skeptical about the validity of Ricardian equivalence because it assumes​ that:

households are forward looking in an extreme sense. financial markets work so well households can borrow or save as much as they would like at current interest rates.

An economy has a marginal propensity to consume of 0.27. The tax rate is 0.25. 1. The value of the multiplier is _____ 2. If the value of the tax rate increased to 0.28​, the value of the multiplier would be ______ 3. Suppose that the government increases purchases by ​$7 billion when the tax rate is 0.25. The change in real GDP is ​_____ billion 4. Suppose that the government increases purchases by ​$7 billion when the tax rate is 0.28. The change in real GDP is _____ billion 5. How do changes in the tax rate affect the amount by which equilibrium real GDP changes as government purchases​ change? As the tax rate​ increases, the multiplier gets ______ and there is a _____ effect on equilibrium real GDP changes as government purchases change.

1. 1.25 2. 1.24 3. 8.75 4. 8.78 5. smaller, smaller

When will fiscal multipliers be large?

1. during severe recessions when there are substantial unemployed resources 2. if the central banks keeps a constant real interest rate

What does it mean to say that fiscal policy is​ sustainable?

A fiscal policy is sustainable if it leads to a constant or decreasing​ debt-to-GDP ratio.

What must happen if there is an increase in the budget deficit in a closed​ economy?

A. A decrease in investment.

Using the​ government's budget​ constraint, the budget deficit is expressed​ as:

A. Gt+TRt−Tt+itBt−1=ΔBt+ΔMBt.

In​ 2012, interest rates in the United States remained at historically low​ levels, and the Fed indicated that it would not increase its target for the federal funds rate until at least​ mid-2015. A July 2012 article in the New York Times​ reported, "[Federal Reserve​ Chairman] Bernanke told Congress that. . . he and other Fed officials had concluded that the central bank needed to expand its stimulus campaign unless the​ nation's economy showed signs of​ improvement, including job​ growth." How is a monetary policy of maintaining low interest rates likely to affect the sustainability of fiscal​ policy?

A. Low interest rates will reduce the interest payments the government must make on its debt and thus will increase the sustainability of fiscal policy.

The economy is in a recession due to a decline in investment spending. The government would

A. decrease​ taxes, thereby decreasing demand and moving real GDP closer to potential GDP.

Productivity and​ long-run growth may increase if deficits are used to​ fund:

A. the capital stock because increases in the capital stock lead to productivity increases along with​ long-run growth.

The chapter opener suggests that deficits are generally a problem for countries. Based on the discussion in this​ section, are there circumstances in which it might be possible that deficits could increase productivity and​ long-run growth? Productivity and​ long-run growth may increase if deficits are used to​ fund:

A. the capital stock because increases in the capital stock lead to productivity increases along with​ long-run growth.

How is discretionary policy different from an automatic​ stabilizer?

A. Discretionary policy is implemented by​ decision, such as the American Recovery and Reinvestment Act of​ 2009, and usually has a much longer response lag. Automatic stabilizers are policies that act in response to the business cycle without explicit​ implementation, such as unemployment insurance.

What is the difference between gross federal debt and gross federal debt held by the​ public?

A. Gross federal debt is essentially the total dollar value of outstanding Treasury bonds while gross federal debt held by the public includes only those bonds held outside the federal government.

Ricardian equivalence is the theory​ that:

A. forward-looking households fully anticipate the taxes implied by government​ spending, so that changes in​ lump-sum taxes have no effect on the economy.

The current fiscal policy of the federal government is unsustainable due​ to:

A. increased government expenditure on entitlement programs.

The national debt

A. increases each year that the federal budget is in deficit. B. is the total value of U.S. Treasury bonds outstanding. C. decreases each year that the federal budget is in surplus. D. imposes a burden on future taxpayers. All of the above.

If consumers believe that deficit reduction must occur in this​ way, they might change their current behavior​ by:

A. increasing their level of saving​ now, which in the long run can increase the capital stock and lead to higher GDP.

​Bernanke's admonition that inadvisable actions not be taken given the​ "fragility of the​ recovery" likely reflected his worry that Congress might

A. initiate tax hikes that could reduce consumption and undermine investment. B. impose a sharp reduction in federal spending. C. pursue a too contractionary fiscal policy. All of the above.

The budget deficit​ is:

A. the difference between government expenditure and tax revenue.

During a severe recession the multiplier is likely to be large because

A.unemployed resources are readily available. B. competition for resources is less intense. C. upward pressure on resource prices is minimal. All of the above. Your answer is correct.

The budget deficit projections in this chapter include net interest payments on the​ debt, the size of which depends on interest rates. What is likely to happen to interest rates and interest payments if the size of the deficit continues to​ increase?

According to the loanable funds​ model, as the budget deficit​ increases, the supply of loanable funds decreases due to the increase in government borrowing. This increases the real interest​ rate, decreases investment​ spending, and increases debt payments.

C​ = $40 million​ + 0.6(1 − ​0.2)Y I​ = $35 million G​ = $31 million NX​ = −​$6 million Based on the above​ data, the equilibrium level of GDP is

B. $192.3 million

While addressing Congress in July​ 2012, Fed Chairman Ben Bernanke offered the following​ opinion: ​ "The most effective way that Congress could help to support the economy right​ now, would be to work to address the​ nation's fiscal challenges in a way that takes into account both the need for​ long-run sustainability and the fragility of the​ recovery." The​ "fiscal challenges" faced by the United States in 2012 were evidenced by its

C. large budget deficit

In January​ 2012, the Congressional Budget Office​ (CBO) predicted that the U.S. federal government would have a budget deficit equal to​ 2.0% of GDP and a cyclically adjusted budget surplus equal to​ 0.7% of GDP in 2014. Was the CBO forecasting that discretionary fiscal policy would be expansionary or​ contractionary?

Contractionary, since the cyclically adjusted budget was forecast to be in surplus.

Are rising interest rates currently a significant concern in the United​ States?

Current debt is not causing much pressure on interest rates and is therefore not a cause for significant concern yet in the United​ States, because the U.S.​ debt-to-GDP ratio is fairly reasonable.

Which of the following fiscal policies might have been implemented earlier if the recession had been​ anticipated?

D. increase in government spending

Gross federal debt held by the public

Debt that includes the bonds and other securities issued by the U.S. Treasury (and a small amount of securities issued by federal agencies) not held by the federal government; also called the national debt

Consider the following​ statement: ​"Monetary policy and fiscal policy are really the same thing because they both can involve the buying and selling of U.S. Treasury​ securities." Do you agree or disagree with this​ statement? Explain your answer.

Disagree. U.S. Treasury​ securities, after they have been​ issued, are used to implement monetary policy because the central bank buys and sells bonds on the secondary market.

Discretionary fiscal policy

Government policy that involves deliberate changes in taxes, transfer payments, or government purchases to achieve macroeconomic policy objectives

The chapter suggests that one reason it was difficult to predict the severity of the 2007−2009 recession is that the financial crisis was not anticipated by most​ economists, and thus the severity of the recession was also not anticipated. What might the failure to anticipate the recession imply about the effectiveness of fiscal policy in preventing or reducing the severity of the​ recession?

If fiscal policymakers are unable to recognize the signs that lead into a​ recession, fiscal policy cannot be effective in preventing them and may have little impact on the severity of crises.

The likely effect of these actions will be to increase ​saving, increase ​investment, and lower the real interest rate. In what ways are the​ short-run and​ long-run effects of this deficit reduction likely to​ differ?

In the​ short-run both saving and investment are likely to fall while the impact on the real interest rate hinges on the response of the central bank.

effects on potential GDP of cutting each of the following taxes

Individual income tax- Reducing the marginal tax rates on individual income will reduce the tax wedge workers face, thereby increasing the quantity of labor supplied. The increase in the labor supplied will increase potential GDP Corporate income tax- The federal government taxes the profits earned by corporations under the corporate income tax; Increased capital and increased efficiency will increase potential GDP Taxes on dividends and capital gains- decreasing taxes on capital gains and dividends leads to a larger capital stock and increases potential GDP

Consider the following​ statement: ​ "Because the government can always print more​ money, the size of the budget deficit​ doesn't matter." Do you agree with this​ statement? Briefly explain.

No, printing money raises nominal interest rates and increases payments on government debt.

budget deficit equation

PD + iB = change B + change MB

Primary Budget Deficit equation

PD = G + TR -T

Automatic stabilizers

Taxes, transfer payments, or government expenditures that automatically increase or decrease along with the business cycle

automatic stabilizers

Taxes, transfer payments, or government expenditures that automatically increase or decrease along with the business cycle reduce the magnitude of the multiplier they have a modest effect on reducing the severity of business cycles but that such stabilizers are nonetheless important because they represent an immediate policy response that does not require direct government action

Shortly after the tax cuts were​ passed, various changes occurred that policymakers could not have​ predicted, such as the terrorist attacks on September​ 11, 2001. What happened to the​ government's budget​ surplus?

The budget balance became a​ deficit, both absolutely and cyclically adjusted.

Most of the programs that we think of as automatic stabilizers did not exist in 1929. Suppose that the automatic stabilizers existed in 1929. Briefly explain the effect these stabilizers would have had on the severity of the Great Depression.

The decline in consumption would have been​ reduced, making the decrease in real GDP and employment smaller than was actually experienced.

Cyclically adjusted budget deficit or surplus

The deficit or surplus in the federal government's budget if real GDP equals potential GDP; also called the full-employment budget deficit or surplus

tax wedge

The difference between the before-tax and after-tax return to an economic activity

What effect would these policies have on the British​ economy?

These contractionary fiscal policies will reduce demand and thus decrease real GDP.

According to an analysis conducted by USA Today​: ​"The typical American household would have paid nearly all of its income in taxes last year to balance the budget if the government used standard accounting rules to compute the​ deficit." Under standard accounting​ rules, future retirement benefit commitments must be included in financial​ statements, but these commitments are not included in CBO calculations of U.S. federal debt. When including these retirement benefit​ figures, the official deficit of​ $1.3 trillion in 2011 would increase to​ $5 trillion.

Using standard accounting rules to measure the deficit would cause the​ debt-to-GDP ratio estimates to be higher. This analysis indicates that the fiscal challenges facing the United States may be understated.

According to the​ chapter, contractionary fiscal policy is rarely used. But during the late​ 1990s, the U.S. government had a budget surplus. Does this surplus imply that fiscal policy in this period was​ contractionary?

Yes. The government had a cyclically adjusted budget balance​ surplus, which implies that fiscal policy was contractionary.

Crowding out

a reduction in private investment causes by gov't budget deficits

Bernanke's admonition that inadvisable actions not be taken given the​ "fragility of the​ recovery" likely reflected his worry that Congress might

all of the above

If a country has a small​ economy, such as​ Sweden, and the economy is open rather than​ closed, then the effectiveness of fiscal policy in that country will

be enhanced since the real interest rate​ doesn't change in a small open economy.

If households are forward​ looking, the increased budget deficits will cause their spending and saving choices to ________. These spending and saving choices will ______ the effectiveness of fiscal policy.

change such that spending falls and saving rises reduce

fiscal policy

changes in federal gov't taxes, purchases of goods and services, and transfer payments that are intended to achieve macroeconomic policy objectives

How is it used to determine whether fiscal policy is expansionary or​ contractionary? If the government is running a cyclically adjusted budget surplus​, discretionary fiscal policy is _________ bc the effect of fiscal policy is to ________ aggregate expenditure.

contractionary decrease

One reason given for the Bush tax cuts in 2001 was to reduce the size of the government budget surplus. Why might the government want to reduce the size of the budget​ surplus? Because a cyclically adjusted surplus is _______. Also, tax cuts are politically ______ and the gov't might believe that consumption might be a ______ effective allocation of resources than gov't spending.

contractionary popular more

When the Fed keeps real interest rates​ constant, the multiplier is likely to be large because

crowding out is negligible. firms continue to have access to loanable funds.

The United Kingdom faced a fiscal crisis during 2010 and 2011. The government had a large budget​ deficit, which it believed needed to be reduced. At the​ time, though, the United Kingdom had only barely recovered from the 2007−2009 recession. Which of the following fiscal policies would achieve the U.K.​ government's budget​ goal?

decrease government purchases

Compared to its effectiveness in a large closed​ economy, fiscal policy in a large open economy​ (with a floating exchange​ rate) is

diminished

Ricardian equivalence

effect of tax cuts on national saving is subject to more debate

The main reason for the projected increases in the U.S. budget deficit in coming years is​ the:

escalating size of entitlement programs such as Social Security and Medicare.

The economy is in a recession due to a decline in investment spending. The government would

increase government​ purchases, thereby increasing demand and moving real GDP closer to potential GDP.

How does a change in the personal tax rate affect the​ multiplier? How does a change in the size of the multiplier affect the​ economy? A decrease in the personal tax rate ______ the size of the​ multiplier, which means that any given change in autonomous spending has a relatively _______ effect on real GDP.

increases larger

Real GDP is above potential GDP after a stock market boom. The government would

increase​ taxes, thereby decreasing demand and moving real GDP closer to potential GDP.

The​ "fiscal challenges" faced by the United States in 2012 were evidenced by its

large budget deficit

With a budget surplus the​ government's expenditure is ______ than its tax revenue while a budget deficit is the situation in which the gov't expenditure is ________ than its tax revenue

less greater

The occurrence of a persistent government budget surplus will result in _____ ​long-term real interest​ rates, a ______ capital​ stock, ______ labor​ productivity, and ______ potential GDP.

lower larger higher higher

Studies have shown a link between rising​ debt-to-GDP ratios and real interest rates. Investment is not the only category of spending that might be sensitive to interest rates. How might consumption be affected by rising interest rates due to a government​ deficit? Will all types of consumption be affected​ equally? Higher interest rates make it more __________ to borrow to finance spending and thus _____ consumption. Purchases of _______ goods will be affected more significantly.

more expensive reduce durable goods

Disposable income

national income plus transfer payments minus personal tax payments

dispoable income

national income plus transfer payments minus personal tax payments

limitations of fiscal policy

policy lags: We have seen that three policy lags make it difficult for monetary policy to reduce the severity of economic fluctuations: recognition, implementation, and impact lags. Congress and the president have access to the same information as do monetary policymakers at the Fed, so the recognition lag for both monetary and fiscal policy is typically several months economic forecasts: not always accurate uncertainty of economic models: magnitude of multipliers vary crowding-out and forward looking households: reduction in private investment caused by government budget deficits & Most economists believe that households and firms are forward looking in the sense that they care about the future when they make decisions about how much to consume and invest (not always true)

What is a cyclically adjusted budget deficit or​ surplus? A cyclically adjusted budget deficit or surplus is the deficit or surplus in the federal​ government's budget if _________ equaled _________.

real GDP potential GDP.

During the 2007−2009 financial​ crisis, among​ policymakers, the Fed was the first to respond with a reduction in​ short-term nominal interest rates in September 2007. Fiscal policy actions came later. Comment on the length of fiscal and monetary policy lags and why monetary action occurred first. While _____ are identical for monetary and fiscal policy, ______ are far shorter for monetary policy. Thus, it was easier for the fed to act immediately than for the president and congress.

recognition lags implementation lags

A higher consumption tax would tend to relatively_________ consumption and _______ savings, thereby causing _________ in investment. Would you expect a consumption tax to have a different effect on consumer savings than an income​ tax?

reduce increase an increase Yes. A higher consumption tax would tend to relatively reduce consumption and increase savings.​ However, a higher income tax would reduce disposable income and thus would reduce consumption as well as savings.

The American Recovery and Reinvestment Act

signed into law on February 17, 2009 The act consisted of increases in transfer payments, increases in government spending on goods and services, tax cuts to households and firms, and aid to state and local governments increased AE and inflation increased employment and GDP

Primary budget deficit

the difference between gov't purchases of goods and services plus transfer payments minus tax revenue

The primary budget deficit is:

the difference between government purchases of goods and services plus transfer payments minus tax revenue.

Seigniorage

the gov'ts profit from issuing fiat money; also called the inflation tax

Budget deficit

the situation in which the gov'ts expenditure is greater than its tax revenue

Budget surplus

the situation in which the gov'ts expenditure is less than its tax revenue

Gross federal debt

the total dollar value of treasury bonds plus the dollar value of the small amount of bonds and other securities issued by the federal agencies

Since the start of the Great Depression

years with federal budget deficits have outnumbered those with​ surpluses, the national debt has​ grown, and the​ debt-to-GDP ratio has fluctuated.

In early​ 2011, Congress renewed the tax cuts first passed by the Bush administration in 2001 for a​ 2-year period. The original tax cuts were set to expire 10 years after they were first passed. Assume that the tax cuts were​ lump-sum tax cuts. If Ricardian equivalence​ holds, what should have been the effect of the original tax​ cuts?

​Lump-sum tax cuts do not affect the decisions to​ save, invest, and work that changes in marginal tax rates do.​ Thus, the original tax cuts probably had no effect on increasing spending.

Consider the following​ statement: ​"The only way for a country with a budget deficit to have sustainable fiscal policy in the long run is to cut government​ spending." Do you agree with this​ statement? Briefly explain.

​No, although spending cuts are part of a sustainable fiscal policy for a country with a​ deficit, other options include tax​ increases, moderate money supply​ increases, and economic growth.

In July​ 2012, the Greek finance minister announced that the​ country's 2012 deficit would be​ 5.4% of​ GDP, down from​ 9% in​ 2011, and primary public expenditure would decline by more than €2.7 billion from the previous year. ​ Aside from spending​ cuts, does Greece have any other alternatives for reducing its​ deficit?

​Yes, tax increases can generate additional revenues to complement the spending cuts in reducing the deficit.