Chapter 13

In early​ 2008, it appeared that the U.S. economy was either in a recession or growing very slowly. President Bush announced a program of tax rebates. This program can be described as​ ___________ and was intended to​ ______________.

discretionary fiscal​ policy; increase consumer spending

The ___ gap was defined as the amount by which the short-run equilibrium level of real GDP exceeds the long-run equilibrium level as given by LRAS.

inflationary

Fiscal policy has typically been associated with the economic theories of John Maynard Keynes and what is now called ___ ___ ___.

traditional Keynesian analysis

The spending decisions of firms, individuals, and other countries' residents depend on the taxes levied on them.

1. Individuals in their role as consumers look to their disposable (after-tax) income when determining their desired rates of consumption. 2. Firms look at their after-tax profits when deciding on the levels of investment per year to undertake. 3. Foreign residents look at the tax-inclusive cost of goods when deciding whether to buy in the United States or elsewhere. Therefore, holding all other things constant, an increase in taxes causes a reduction in aggregate demand because it reduces consumption, investment, or net exports.

The Laffer curve indicates which of the​ following? A. There is an ideal​ tax-revenue-maximizing tax rate for government taxes. B. There is an ideal amount of government spending that will lead to full national employment. C. There is an ideal income tax rate on​ individuals, depending on their consumption behavior. D. There is an ideal interest rate that will maximize investment spending.

A. There is an ideal​ tax-revenue-maximizing tax rate for government taxes.

How do automatic stabilizers work? A. When a decline in national income occurs there will be a reduction in income tax collections and an increase in unemployment compensation and welfare payments muting the reduction in planned expenditures that would have otherwise resulted. B. When an increase in national income occurs there will be an increase in income tax collections and an increase in unemployment compensation and welfare payments muting the increase in planned expenditures that would have otherwise resulted. C. When an increase in national income occurs there will be a reduction in income tax collections and a decrease in unemployment compensation and welfare payments muting the reduction in planned expenditures that would have otherwise resulted. D. When a decline in national income occurs there will be an increase in income tax collections and an increase in unemployment compensation and welfare payments muting the reduction in planned expenditures that would have otherwise resulted.

A. When a decline in national income occurs there will be a reduction in income tax collections and an increase in unemployment compensation and welfare payments muting the reduction in planned expenditures that would have otherwise resulted. A decrease in income causes tax revenues to decrease. It also increases government aid to families through welfare and unemployment compensation.

The Congressional​ meetings, discussions,​ arguments, debates over fiscal policy and the subsequent signing or vetoing by the President of a bill are part of the A. action time lag. B. effect time lag. C. political time lag. D. recognition time lag.

A. action time lag.

When there is an economic​ downturn, Congress and the President use fiscal policy to stabilize real GDP. But the conduct of the fiscal policy involves several time​ lags, such as the recognition time lag that causes a delay in identification of the economic​ problem, the action time lag that is caused by the delay in Congressional approval of the​ policy, and the effect time lag that arises because policy actions take time to exert their full effects on the economy. These time lags could actually cause discretionary fiscal policy to A. destabilize real GDP because by the time a policy has begun to have its​ effects, the economy might already be recovering and the policy action might push real GDP up faster than​ intended, thereby making real GDP less stable. B. destabilize real GDP because by the time a policy has begun to have its​ effects, the economy might already be in worse trouble and the policy action might push real GDP down faster than​ intended, thereby making real GDP less stable. C. stabilize real GDP because by the time a policy has begun to have its​ effects, the economy might already be recovering and the policy action might push real GDP down faster than​ intended, thereby making real GDP more stable. D. stabilize real GDP because by the time a policy has begun to have its​ effects, the economy might already be recovering and the policy action might push real GDP up faster than​ intended, thereby making real GDP more stable.

A. destabilize real GDP because by the time a policy has begun to have its​ effects, the economy might already be recovering and the policy action might push real GDP up faster than​ intended, thereby making real GDP less stable.

Suppose the government decreases lumpminus−sum taxes. This causes A. disposable income to​ increase, which causes consumption spending to decrease and aggregate demand to increase. B. disposable income to​ decrease, which causes aggregate supply to decrease. C. government spending to​ decrease, which causes aggregate demand to decrease. D. consumption spending to decrease and spending on imports to increase. The effect on aggregate demand depends on whether domestic spending or spending on imports decreased the most.

A. disposable income to​ increase, which causes consumption spending to decrease and aggregate demand to increase.

Expansionary fiscal policy that creates a budget deficit can lead to crowding out. This crowding out effect is exhibited by A. increased government expenditures and decreased investment. B. increased government expenditures and decreased interest rates. C. increased taxes and increased investment. D. decreased government expenditures and decreased investment.

A. increased government expenditures and decreased investment.

During normal economic​ times, when there is not​ "excessive" unemployment or​ inflation, discretionary fiscal policy A. is probably not very effective due to lags and the uncertainty created by repeated tax policy changes. B. is used frequently to effectively​ fine-tune the economy. C. is a way of effectively spurring economic growth. D. is not used due to legal restrictions on the ability of Congress to make policy.

A. is probably not very effective due to lags and the uncertainty created by repeated tax policy changes.

The U.S. government is in the midst of spending more than​ $1 billion on seven buildings containing more than​ 100,000 square feet of space to be used for study of infectious diseases. Prior to the​ government's decision to construct these​ buildings, a few universities had been planning to build essentially the same facilities using privately obtained funds. After construction on the government buildings​ began, however, the universities dropped their plans. The​ government's $1 billion expenditure will A. not push U.S. real GDP above the level it would have reached in the absence of the​ government's construction spree because this expenditure would have been undertaken by universities. B. push U.S. real GDP above the level it would have reached in the absence of the​ government's construction spree because the universities dropped their plans. C. not push U.S. real GDP above the level it would have reached in the absence of the​ government's construction spree because both the government and the universities would require borrowed funds. D. push U.S. real GDP above the level it would have reached in the absence of the​ government's construction spree because there is a multiplier effect.

A. not push U.S. real GDP above the level it would have reached in the absence of the​ government's construction spree because this expenditure would have been undertaken by universities.

In the traditional Keynesian​ model, if the government increases​ spending, then A. real Gross Domestic Product​ (GDP) will rise and the price level will remain constant. B. real Gross Domestic Product​ (GDP) will increase and the price level will fall. C. both real Gross Domestic Product​ (GDP) and the price level will rise. D. real Gross Domestic Product​ (GDP) will remain constant and the price level will rise.

A. real Gross Domestic Product​ (GDP) will rise and the price level will remain constant.

Fiscal policy is defined as A. the discretionary changing of government expenditures​ and/or taxes to achieve macroeconomic economic goals. B. the use of the taxing power of the government to redistribute wealth in a socially acceptable manner. C. the design of a tax system to transfer income from large corporations to the poor. D. the use of Congressional power to pursue social and political goals.

A. the discretionary changing of government expenditures​ and/or taxes to achieve macroeconomic economic goals.

To the extent that a direct expenditure offset results from an expansionary fiscal​ policy, A. the stimulative effect will be less than expected. B. the fiscal policy will not be discretionary. C. the stimulative effect will be more than expected. D. the time lags associated with the implementation of fiscal policy will shorten.

A. the stimulative effect will be less than expected.

Direct expenditure offsets

Actions on the part of the private sector in spending income that offset government fiscal policy actions. Any increase in government spending in an area that competes with the private sector will have some direct expenditure offset.

Which of the following is not an automatic​ stabilizer? A. Unemployment compensation. B. Defense spending. C. Progressive tax rates. D. All of the above are automatic stabilizers.

B. Defense spending. This is discretionary. Congress and the President decide how much defense spending will take place.

Which of the following statements is​ correct? A. Governments have learned how to use fiscal policy to​ fine-tune the economy. B. Governments have a difficult time​ fine-tuning the economy by using fiscal policy because there are several time lags and these are often variable. C. Governments have the knowledge about how to​ fine-tune the​ economy, but the effect time lag generates a backlash from voters that makes it difficult to implement. D. Governments have a difficult time​ fine-tuning the economy by using fiscal policy because of the automatic stabilizers.

B. Governments have a difficult time​ fine-tuning the economy by using fiscal policy because there are several time lags and these are often variable.

Which of the following statements is true when considering time​ lags? A. The effect time lag depends on the action of presidential economic advisors who will evaluate the effectiveness level of the fiscal policy. B. Time lags in fiscal policy can be extremely long and may take several years before any impact is felt. C. The shortest time lag is the action time lag since Congress has a set period to debate fiscal policy matters. D. Due to the fiscal policy variables​ (G and​ T) being flow​ variables, which are measured over a set​ period, time lags are confined to the same​ period, that is no longer than one year.

B. Time lags in fiscal policy can be extremely long and may take several years before any impact is felt. Time lags have no set time​ period, so they can be very long.

In the traditional Keynesian​ model, if the government decreases​ spending, then A. consumption will increase or​ decrease, and so real Gross Domestic Product​ (GDP) will increase or decrease depending on the change in consumption. B. consumption will​ decrease, and so real Gross Domestic Product​ (GDP) will decrease by more than the increase in government spending. C. consumption will remain the​ same, and so real Gross Domestic Product​ (GDP) will increase by the same amount of the increase in government spending. D. consumption will​ decrease, and so real Gross Domestic Product​ (GDP) will decrease by less than the increase in government spending.

B. consumption will​ decrease, and so real Gross Domestic Product​ (GDP) will decrease by more than the increase in government spending.

The traditional Keynesian approach to fiscal policy assumes A. prices are flexible while interest rates are not. B. current taxes are the only taxes taken into account by firms and consumers. C. the focus of attention should be the long run. D. exchange rates are fixed.

B. current taxes are the only taxes taken into account by firms and consumers.

According to traditional Keynesian​ analysis, fiscal policy operates by A. informing consumers and business people about its plans for the economy so they will know how to adjust their behavior. B. directly affecting aggregate demand. C. directly affecting aggregate supply. D. indirectly affecting aggregate demand through its effect on interest rates.

B. directly affecting aggregate demand.

The amount of time that elapses between the implementation of a policy and the results of that policy is A. the recognition time lag. B. the effect time lag. C. the action time lag. D. fiscal policy.

B. the effect time lag.

In January​ 2009, the President submitted a bill to Congress that was designed to stimulate the economy and increase employment. The legislation was passed in March​ 2009, and the spending occurred from June 2009 to September 2010.​ Consequently, A. the economy should have been at full employment by December 2009. B. the full effect of the spending would be felt some time after September 2010 because the full multiplier effects could not be felt until all the increase in spending took place. C. the full impact of the bill would be felt by the end of September 2010. D. the full impact of the bill would be felt by March 2009 because people anticipated the effects of the increased spending.

B. the full effect of the spending would be felt some time after September 2010 because the full multiplier effects could not be felt until all the increase in spending took place.

The assumption that the price level is fixed in the Keynesian model allows A. the​ short-run aggregate supply curve to be vertical. B. the multiplier to be fully applied. C. the government budget to be balanced. D. weakens the effect of the multiplier.

B. the multiplier to be fully applied.

During normal​ times, fiscal policy probably achieves most of its impact through A. the workings of time lags. B. the workings of automatic stabilizers. C. the workings of discretionary fiscal policy. D. It is always ineffective.

B. the workings of automatic stabilizers.

According to the supply side economists​ a(n) decreasedecrease in marginal tax rates will A. decrease the opportunity cost of leisure. B.either decrease or increase the amount of leisure time chosen by workers. C. decrease disposable income. D. decrease aggregate demand .

B.either decrease or increase the amount of leisure time chosen by workers. It depends the respective sizes of the substitution and income effects from the change in the marginal tax rates.

When real Gross Domestic Product​ (GDP) falls, which of the following will automatically​ occur? A. A decrease in all tax rates B. An increase in income tax revenues C. A decrease in income tax revenues D. A decrease in unemployment compensation expenditures

C. A decrease in income tax revenues

Suppose that the economy is presently operating at full employment. If there is a decreasea decrease in national​ income, which of the following will occur​ automatically? A. A decrease in unemployment compensation spending. B. A decrease in tax rates. C. A decrease in tax revenues. D. An increase in tax rates.

C. A decrease in tax revenues.

Suppose that Congress enacts a significant tax cut with the expectation that this action will stimulate aggregate demand and push up real GDP in the short run. In​ fact, however, neither real GDP nor the price level changes significantly as a result of the tax cut. This outcome can be explained by all of the​ following, except one. Which one of the following is the​ exception? A. The​ Fed's contractionary monetary policy. B. The Ricardian Equivalence Theorem. C. Automatic stabilizers. D. Indirect crowding out.

C. Automatic stabilizers.

The proposition that increases in government spending that raise the government budget deficit has no effect on aggregate demand is called the A. federalism effect. B. ​open-economy effect. C. Ricardian equivalence theorem. D. ​interest-rate effect.

C. Ricardian equivalence theorem.

Government-provided unemployment insurance is an example of A. an automatic monetary stabilizer. B. a monetary stabilizer. C. an automatic fiscal stabilizer. D. a discretionary fiscal stabilizer.

C. an automatic fiscal stabilizer.

An advantage of automatic stabilizers over discretionary fiscal policy is that A. the Ricardian equivalence theorem applies more readily to automatic stabilizers than to discretionary fiscal policy. B. only policymakers are involved in implementing automatic stabilizers. C. automatic stabilizers are not subject to the same time lags as discretionary fiscal policy. D. automatic stabilizers can be easily​ fine-tuned to move the economy to full employment.

C. automatic stabilizers are not subject to the same time lags as discretionary fiscal policy.

Increased government spending crowds out investment due to A. the existence of interest rate floors. B. an increased money supply. C. higher interest rates. D. stricter government regulations.

C. higher interest rates.

A progressive tax system is one in which the tax rates A. are dependent on the progress of the​ economy; for example if real GDP grows by​ 3% then tax rates grow by​ 3%. B. remain constant as income increases. C. increase as income increases. D. decrease as income increases.

C. increase as income increases.

The purpose of automatic stabilizers is to A. stabilize tax revenue and government expenditures. B. make sure people have a living wage. C. lessen the impact of unemployment in a recession and slowdown inflation during an expansion. D. act as a safety measure preventing the government from using fiscal policy.

C. lessen the impact of unemployment in a recession and slowdown inflation during an expansion.

An increase in government spending shows up exclusively as a change in real GDP when A. the employment level is assumed to be constant. B. the level of nominal GDP is assumed to be constant. C. the price level is assumed to be constant. D. taxes increase by the same amount as government spending.

C. the price level is assumed to be constant.

___ ___ dilutes the effect of expansionary fiscal policy, and a recessionary gap remains.

Crowding out

Fiscal policy is likely to be more effective A. when there are less offsetting reductions in private sector spending. B. when government borrowing does not increase interest rates substantially. C. during abnormal times as opposed to more normal times. D. All of the above.

D. All of the above. These are the situations in which fiscal policy has the greatest effectiveness.

Given the existence of time​ lags, there is potential danger in using fiscal policy. Which of the following outcomes could occur because of the existence of such time​ lags? A. Subsequent changes in the economy have caused the government to change its fiscal policy making it less consistent and the government less trustworthy. B. Governments may undershoot the necessary change to government spending or taxes to reach full employment real GDP because they are uncertain what other factors may impact the economy. C. Governments may overshoot the full employment real GDP as the economy has improved by the time the policy takes effect. D. Each of these scenarios are potential outcomes because of the existence of time lags.

D. Each of these scenarios are potential outcomes because of the existence of time lags.

Which of the following must be true if the balanced budget multiplier to equal​ one? A. The​ government's budget must be balanced to begin with. B. The increases in income stemming from a change in government spending must be the same as the change in income stemming from the change in taxes. C. Taxes equal government spending. D. The increases in income stemming from a change in government spending must be greater than the change in income stemming from the change in taxes.

D. The increases in income stemming from a change in government spending must be greater than the change in income stemming from the change in taxes.

The Laffer curve indicates A. an inverse relationship between tax rates and tax revenues. B. a positive relationship between tax rates and tax revenues. C. by how much the aggregate demand curve shifts when tax rates are changed. D. both options A and B.

D. both options A and B. If the current marginal tax rate is below the optimum rate then increasing it will increase tax revenue. If the current marginal tax rate is above the optimum rate then increasing it will decrease tax revenue.

When the economy is operating on the LRAS​ curve, then expansionary fiscal policy will A. generate an increase in real GDP without higher prices in the short​ run, but then real GDP will return to its long−run ​level, and the price level will increase. B. generate higher prices in the short​ run, but will induce aggregate supply to increase in the long run. C. generate an increase in real GDP and higher prices in both the short run and the long run. D. generate an increase in real GDP and higher prices in the short​ run, but then real GDP will decrease to its long−run ​level, and the price level will increase some more.

D. generate an increase in real GDP and higher prices in the short​ run, but then real GDP will decrease to its long−run ​level, and the price level will increase some more.

The Keynesian perspective on the effect of an increase in taxes is that this policy action A. increases current consumption and reduces future consumption. B. generates reductions in consumption and an increase in saving to pay for the new taxes. C. has no impact on consumption. D. generates reductions in consumption and in saving.

D. generates reductions in consumption and in saving.

If the government increases aggregate demand when the economy is at both​ short-run and​ long-run equilibrium, the full​ long-run effect of this fiscal policy will be to A. increase real Gross Domestic Product​ (GDP). B. decrease both real Gross Domestic Product​ (GDP) and the price level. C. increase either the real Gross Domestic Product​ (GDP) or the price​ level, depending on the length of the time lag. D. increase the price level.

D. increase the price level.

The idea that a tax reduction funded by government borrowing has no effect on aggregate demand is known as A. the​ expenditure-offset theorem. B. the Keynesian Cross. C. the balanced budget multiplier. D. the Ricardian equivalence theorem.

D. the Ricardian equivalence theorem.

Automatic stabilizers are​ so-named because A. they are automatically undertaken by the Federal Reserve Bank to reduce budget deficits. B. the policy suggestions of the Council of Economic Advisors are automatically followed. C. the policy suggestions of the Office of Management and Budget are automatically followed. D. they occur automatically when real GDP changes.

D. they occur automatically when real GDP changes.

Whenever government spending is a substitute for private spending, however, a rise in government spending causes a direct reduction in private spending to offset it.

In the extreme case, the direct expenditure offset is dollar for dollar, so we merely end up with a relabeling of spending from private to public. Otherwise stated, if there is a full direct expenditure offset, the government spending multiplier is zero.

Permanent income hypothesis

Proposes that an individual's current flow of consumption depends on the individual's permanent, or anticipated lifetime, income.

Automatic, or built-in, stabilizers

Special provisions of certain federal programs that cause changes in desired aggregate expenditures without the action of Congress and the president. Examples are the federal progressive tax system and unemployment compensation.

​Automatic, or​ built-in, stabilizers

Special provisions of certain federal programs that cause changes in desired aggregate expenditures without the action of Congress and the president. Examples are the federal progressive tax system and unemployment compensation.

Impact fiscal multiplier

The actual immediate multiplier effect of a fiscal policy action after taking into consideration direct fiscal offsets and other short-term crowding out of private spending.

Fiscal policy

The discretionary changing of government expenditures or taxes to achieve national economic goals, such as high employment with price stability.

Cumulative fiscal multiplier

The multiplier effect of a fiscal policy action that applies to a long-run period after all influences on equilibrium real GOP have been taken into account.

Ricardian equivalence theorem

The proposition that an increase in the government budget deficit has no effect on aggregate demand.

Crowding-out effect

The tendency of expansionary fiscal policy to cause a decrease in planned investment or planned consumption in the private sector. This decrease normally results from the rise in interest rates.

Supply-side economics

The theory that creating incentives for individuals and firms to increase productivity will cause the aggregate supply curve to shift outward.

Action time lag

The time between recognizing an economic problem and implementing policy to solve it. The action time lag is quite long for fiscal policy, which requires congressional approval.

Recognition time lag

The time required to gather information about the current state of the economy.

Effect time lag

The time that elapses between the implementation of a policy and the results of that policy.

A person's ___ and ___ decisions realistically depend on both current income and anticipated future income.

consumption; saving

The ___ gap was defined as the amount by which the current level of real GDP falls short of the economy's potential production if it were operating on its LRAS curve.

recessionary

People who support the notion that reducing tax rates does not necessarily lead to reduced tax revenues are called ___ ___.

supply-side economists