ECON 1115 chapter 16 homework

Which of the following could be true? (multiple answers) A. The federal budget deficit increases while interest rates fall. B. The deficit is larger during a recession. C. The deficit gets larger while inflation increases. D. None of the above

A. The federal budget deficit increases while interest rates fall. B. The deficit is larger during a recession. C. The deficit gets larger while inflation increases. The first choice suggests that a deficit can increase at the same time interest rates fall. If total spending is shrinking, tax receipts will fall and the budget deficit would increase. At the same time, the demand for money will be decreasing, causing interest rates to fall. The second choice suggests a larger deficit during a recession. If total spending is shrinking, the budget deficit would increase as income and then tax receipts decrease. Option C says that the deficit gets larger as inflation increases. If government spending is increasing or tax rates are being lowered, the deficit will rise and there will be inflationary pressures. Causation is crucial in understanding the interaction of total spending and deficits.

Assume the economy faces high unemployment but stable inflation. Which combination of government policies is most likely to reduce unemployment? A. The purchase of government securities in the open market and an increase in government spending. B. The sale of government securities in the open market and a decrease in taxes. C. The sale of government securities in the open market and a decrease in government spending. D. The purchase of government securities in the open market and an increase in taxes.

A. The purchase of government securities in the open market and an increase in government spending.

Which of the following would weaken the argument for the use of discretionary monetary policy? A. The term length for Fed board members is shortened from 14 years to 2 years. B. The accuracy of forecasts is improved through new computer techniques. C. Congress requires a balanced budget at all times. D. The velocity of money varies greatly over time.

A. The term length for Fed board members is shortened from 14 years to 2 years. A shorter term length for board members would mean they are more likely to be influenced by the political process since they are nominated by the president and confirmed by the Senate. Board members who are more sensitive to political concerns would have a bias toward expansionary policy because politicians are more likely to be reelected when unemployment is low. As a result, we might end up with inflation that is too high if the Fed followed discretionary policy rather than a monetary policy rule.

"An increase in the budget deficit can be beneficial for the economy," said a member of Congress during the November budget debates. Could this statement be true? A. Yes B. No

A. Yes An increase in the budget deficit will benefit the economy when the economy is in a recession. An increase in government spending or a decrease in taxes will cause growth in total spending.

If an economy appears to be growing rapidly and inflation appears to be becoming a serious problem, which of the following fiscal policies would be appropriate? A. A decrease in capital gains taxes B. A decrease in government spending C. A reduction in personal income taxes D. An increase in government transfer payments

B. A decrease in government spending In an inflationary period, the problem may be too much spending. The fiscal policy to restrict spending includes decreasing government spending, increasing taxes, or decreasing transfer payments. Any of these three will have a multiplied negative effect on spending and will return the economy back to full-employment. Of the options available to you in the question, a decrease in government spending would have the effect on spending that you would want to reduce inflation. Decreasing government spending would have a multiplied negative effect on total spending, which would in turn reduces aggregate demand.

Once decisions have been made to use monetary policy and fiscal policy to solve a problem, it will take less time for monetary policy to have an effect on real GDP and the inflation rate than would an increase in government spending. A. True B. False

B. False Monetary policy will take longer, because monetary policy works by changing the money supply, which starts a long process. The change in the money supply changes interest rates, which changes investment spending, which changes total spending. Fiscal policy works to change total spending directly in the case of changes in government spending and almost directly in the case of changes in taxes.

Which of the following groups would prefer monetary policy to ameliorate a recession, as opposed to fiscal policy? A. Borrowers B. Lenders

B. Lenders ? but the answer says A?

Consider the following quote: "Over one and a half million people were laid off from jobs following the doubling of oil prices in 1979." What was the policy dilemma faced by monetary and fiscal policy makers? A. Rising prices and falling unemployment B. Rising prices and rising unemployment C. Rising prices and rising interest rates D. Rising prices and increased consumer confidence

B. Rising prices and rising unemployment The policy dilemma is rising prices and rising unemployment. If policy is used to stimulate the economy, inflation will rise further. If policy is used to slow the economy down, unemployment will rise. If tax and spending policy is used to increase supply, it is likely that spending will increase before supply, thus causing more inflation.

Which of the following statements comparing the lags of monetary and fiscal policy is accurate? A. The lag between the initiation of fiscal policy and the effect on real GDP is longer than the lag between the initiation of monetary policy and its effects. B. The policy-making lag for fiscal policy is longer than monetary policy. C. Monetary policy takes longer to have an effect on the economy if the economy is growing than if the economy is entering a recession. D. The total amount of time from beginning to end for fiscal policy is significantly shorter than for monetary policy.

B. The policy-making lag for fiscal policy is longer than monetary policy. Fiscal policy generally requires approval by Congress, a process which can take quite a long time. Even after the policy has been approved by Congress, it takes time for the actual changes in spending to take place.

If the economy were encountering a severe recession, proper monetary and fiscal policies would call for A. selling government securities, raising the reserve ratio, lowering the discount rate, increasing interest paid on reserves held at Fed banks, and a budgetary surplus. B. buying government securities, reducing the reserve ratio, reducing the discount rate, reducing interest paid on reserves held at Fed banks, and a budgetary deficit. C. buying government securities, raising the reserve ratio, raising the discount rate, reducing interest paid on reserves held at Fed banks, and a budgetary surplus. D. buying government securities, reducing the reserve ratio, raising the discount rate, reducing interest paid on reserves held at Fed banks, and a budgetary deficit.

B. buying government securities, reducing the reserve ratio, reducing the discount rate, reducing interest paid on reserves held at Fed banks, and a budgetary deficit.

Expansionary fiscal policy will cause which of the following? A. An increase in investment, if real GDP is already above the potential level B. A decrease in investment, if real GDP is significantly below the level of potential real GDP C. A rise in interest rates D. A decrease in the money supply

C. A rise in interest rates Expansionary fiscal policy will increase aggregate demand and in turn aggregate output. But higher aggregate output will increase money demand, which will cause interest rates to rise. Answer B is wrong; if GDP is significantly below potential, an increase in GDP will lead to increased investment. Crowding out is unlikely to have an effect that is so large that investment falls, if the economy is starting at less than potential real GDP.

Assume that we are currently producing less than the potential level of GDP. Which of the following is a valid argument for active use of monetary policy instead of fiscal policy? A. Fiscal policy is not effective in stimulating aggregate demand B. Monetary policy stimulates aggregate supply C. Fiscal policy may cause crowding out of investment D. Fiscal policy will lead to lower interest rates

C. Fiscal policy may cause crowding out of investment Fiscal policy may cause crowding out of investment when the economy is nearing full employment. If the government is concerned with the amount of investment and long-run economic growth, the desired policy might be to use an increase in the money supply to lower interest rates to increase investment.

According to the advocates of crowding out, an increase in government spending will cause the demand for money to ______________, then interest rates to ______________, which in turn causes investment spending to ______________. A. Decrease, decrease, increase B. Increase, decrease, increase C. Increase, increase, decrease D. Decrease, increase, increase

C. Increase, increase, decrease An increase in federal spending would have a multiplied positive effect on total spending. This means that people are spending more and will demand more money. As the demand for money increases, interest rates will rise. With higher interest rates, the cost of borrowing money for investment will be higher, so investment will fall. This is part of the explanation of the "crowding out" phenomenon.

An economy is producing at a level of output that is equal to the full-employment level of output. Prices of a fundamental resource, such as oil, decrease significantly. What would be the best monetary policy? A. A stimulative policy B. A restrictive policy C. No monetary policy would be required. D. There is no obviously correct policy, unless you can specify your goals.

C. No monetary policy would be required. There is a trade-off. Two problems (higher unemployment and higher inflation) have been created. Either policy will make one of the problems worse.

The effectiveness of monetary policy is limited by the slope of A. the demand for money function. B. the investment demand function. C. both the money and investment demand functions. D. neither the money nor investment demand functions.

C. both the money and investment demand functions.

Monetary policy is thought to be A. equally effective in moving the economy out of a depression as in controlling demand-pull inflation. B. more effective in moving the economy out of a depression than in controlling demand-pull inflation. C. more effective in controlling demand-pull inflation than in moving the economy out of a recession. D. only effective in moving the economy out of a depression.

C. more effective in controlling demand-pull inflation than in moving the economy out of a recession.

Which of the following accurately refers to "crowding in"? A. Increased consumption in response to increased government spending B. Increased investment in response to expansionary monetary policy C. Increased consumption in response to contractionary fiscal policy D. Increased investment in response to expansionary fiscal policy.

D. Increased investment in response to expansionary fiscal policy When the federal budget deficit is increased there are two effects; which one dominates will determine whether crowding out or crowding in occurs.An increased deficit means that government spending has increased or taxes have decreased. The stimulus to spending is a positive one and will cause more investment as real GDP increases. The increased deficit also means that interest rates will increase, raising the cost of investment. Thus, investment will fall. If the latter effect is larger than the first, we will have crowding out. Investment spending decreases. If the first is larger, we have crowding in, that is, an increase in investment.

A temporary income tax cut will be ______________ effective as a fiscal policy than a permanent change ______________. A. More; because the government deficit will not increase by as much as it will if the tax cut is permanent B. More; because future income is not affected C. Less; because the government deficit will increase by more than it will if the tax cut is permanent D. Less; because future income is not affected

D. Less; because future income is not affected A tax cut that is permanent increases current disposable income and future disposable income. Both current and future income affect current consumption. A temporary tax cut only affects current disposable income and thus has a smaller effect on consumption.The effect on future income is the relevant explanation, not the effects of the tax change on the deficit.

An economy is producing at a level of output that is equal to the full-employment level of output. Prices of a fundamental resource, such as oil, increase significantly. What would be the best monetary policy? A. A stimulative policy B. A restrictive policy C. A stimulative policy followed by a restrictive policy D. A restrictive policy followed by a stimulative policy E. There is no obviously correct policy, unless you can specify your goals.

E. There is no obviously correct policy, unless you can specify your goals. There is a trade-off. Two problems (higher unemployment and higher inflation) have been created. Either policy will make one of the problems worse.