Econ Final

Which of the following are policy instruments available to the Fed as it tries to achieve its macroeconomic goals? 1. government expenditure on goods and services and taxes 2. the government budget deficit or surplus 3. changes in the federal funds rate

3. changes in the federal funds rate

If the economy slips into recession, the Fed ________ the federal funds rate, which ________ the short-term interest rate, and ________ the quantity of money.

lowers; lowers; increases

When the Fed ________ the federal funds rate, other short-term interest rates ________ and the exchange rate ________.

raises; rise; rises

In the United States,

the Federal Reserve sets monetary policy.

Control of monetary policy rests with

the Federal Reserve.

The federal funds rate is ________ of the Fed

the monetary policy instrument

During the late 1960s, real GDP increased, unemployment fell, and the inflation rate started to rise. Which would have been the appropriate federal government policy combination to improve economic performance by lowering the inflation rate?

decrease government expenditures, increase taxes, decrease the quantity of money

Which of the following is an example of a fiscal stimulus?

decrease in taxes

The higher the federal funds rate, the ________ the opportunity cost of holding reserves, which ________ the incentive to economize on reserves.

a. higher; increases

The Fed decreases the quantity of money to counteract

an inflationary gap.

In order to help the economy recover from a recession using fiscal policy, the government can ________ so that aggregate demand increases

cut taxes

An example of a discretionary fiscal stimulus policy is

cutting taxes

If the economy is in an equilibrium with real GDP less than potential GDP, a fiscal stimulus could move the economy toward potential GDP by simultaneously ________ taxes and ________ government expenditures on goods and services.

cutting; increasing

Suppose the economy is in an equilibrium in which real GDP is less than potential GDP. To increase real GDP, the government can use a fiscal stimulus of

decreasing taxes and/or increasing government expenditure.

An economy is at a short-run equilibrium as illustrated in the above figure. An appropriate fiscal policy option to move the economy to full employment is to

increase government expenditure and move the economy to a full-employment equilibrium at point b.

Ignoring any supply-side effects, to close a recessionary gap of $100 billion with a government expenditure multiplier of 5, the government could

increase government expenditure on goods and services by $20 billion

During the Great Depression, real GDP decreased, unemployment soared, and the inflation rate was negative. Which would have been the appropriate federal government policy combination to improve economic performance?

increase government expenditure, decrease taxes, increase the quantity of money

To eliminate a recessionary gap, the government can ________ government expenditures on goods and services or ________ taxes.

increase; decrease

Which of the following is NOT a monetary policy goal?

keeping a high exchange rate for the dollar

Monetary policy decisions are made by the

Federal Open Market Committee

To eliminate a recessionary gap, what fiscal policy should the government pursue?

A recessionary gap occurs when real GDP is less than potential GDP. To restore full employment, the government should increase its expenditures on goods or services or decrease its taxes.

Describe the difference between discretionary and automatic fiscal policy.

Discretionary fiscal policy is initiated by an act of Congress. Automatic fiscal policy is determined by the state of the economy; no act of Congress is necessary to initiate automatic fiscal policy.

Explain the difference between discretionary and automatic fiscal policy. Provide examples of each.

Discretionary policy is an action that is initiated by an act of Congress such as implementation of a spending program or a change to tax law. Automatic fiscal policy is triggered by the state of economy and happens naturally such as a decrease in tax revenues as a result of a fall in incomes or an increase in unemployment payments due to an increase in the unemployment rate

Compare the views of Keynesian and mainstream economists on the effects fiscal stimulus has on real GDP and employment.

Keynesian economists believe fiscal stimulus results in a boost of real GDP and employment as a result of the multiplier effect. Mainstream economists believe the Keynesian economists overstate the size of the multiplier. They believe the stimulus "crowds out" private expenditures and investments and create a greater burden of government debt on future generations.

The ________ view says that fiscal stimulus has a multiplier effect that makes it a ________ tool to fight a deep recession.

Keynesian; powerful

Explain monetary policy goals and discuss any goal conflicts in the long run and the short run.

Monetary policy has three goals: price level stability, maximum employment, and moderate long-term interest rates. In the long run, these goals all coincide and are best met by keeping the inflation rate low. In the short run, however, there is a tradeoff: Higher inflation can lead to lower unemployment and hence higher employment. So in the short run, higher employment can be attained but at the cost of higher inflation.

Distinguish between monetary policy instruments and goals.

Monetary policy instruments are the variables the Fed can use to conduct monetary policy and reach its goals. These include the monetary base or the federal funds rate. Monetary policy goals are the ultimate objectives for the Fed. These include price stability and full employment.

If the Fed wants to close a recessionary gap, should it buy or sell government securities? Why?

The Fed should lower the federal funds rate by purchasing government securities. When the Fed buys government securities, the quantity of money increases and quantity of loans increases. The increase in loans increases the supply of loanable funds so the real interest rate falls. As a result, consumption expenditure, investment, and net exports increase, which increases aggregate demand. The increase in aggregate demand increases real GDP, which is the policy required when real GDP is less than potential GDP, that is, when the economy has a recessionary gap.

"As the saying goes, the only sure things in life are death and taxes. This saying points out the result that everything having to do with taxes is an automatic fiscal policy." Is the preceding analysis correct or incorrect? Explain your answer.

The analysis is incorrect because whenever Congress changes the tax law, it is a discretionary fiscal policy. For instance, if Congress passes a tax cut, the change in taxes is a discretionary fiscal policy. However, for any given set of tax laws, a change in the state of the economy will automatically change the tax revenues and so for a given set of tax laws, tax revenue do operate as an automatic fiscal policy.

23) The above table gives a country's government outlays and tax revenue for 2008 through 2012. During which years did the country have a balanced budget, budget surplus, and budget deficit?

The country had a balanced budget in 2011 because in that year government outlays equaled tax revenues. The country had a budget surplus in 2008 and 2009 because in those years tax revenues exceeded government outlays. The country had a budget deficit in 2010 and 2011 because in those years government outlays exceeded tax revenues.

A country reports that its government outlays total $0.8 trillion and its tax revenues total $0.6 trillion. Does the country have a budget surplus or deficit and what is the surplus or deficit?

The country has a budget deficit. The deficit equals $0.2 trillion.

Depending on the relative size of the federal government's expenditures and tax revenues, the federal government's budget can be in three possible conditions. What are the three possible conditions and what is the relationship of federal government expenditures and tax revenues for each?

The federal government's budget could have a budget surplus, a budget deficit, or a balanced budget. A budget surplus occurs when tax revenues are greater than government expenditures; a deficit occurs when tax receipts are less than government expenditures; and a balanced budget occurs when tax revenues are equal to government expenditures.

"The Federal Open Market Committee (FOMC) is the group within the Federal Reserve that makes monetary policy decisions. The FOMC meets twice a year and each meeting lasts eight days." Are these two statements correct or incorrect? Why?

The first statement is correct. The second statement is incorrect. It is indeed the case that the FOMC is the group within the Fed that makes monetary policy decisions. However the FOMC meets eight times a year, not twice. Of these eight meetings, six are for one day and two of the meetings last for two days.

The Fed increases the quantity of money to counteract

a recessionary gap.

1. If the economy is in equilibrium with real GDP less than potential GDP, there is ________ gap, and a fiscal policy that ________ is appropriate.

a recessionary; increases aggregate demand

An economy is experiencing a recession and policy makers are considering using discretionary fiscal policy to eliminate the recessionary gap. What are the four limitations that policymakers face when using discretionary fiscal policy? Briefly discuss each.

The limitations are law-making time lags, a shrinking area of law-maker discretion, problems estimating potential GDP, and difficulty making economic forecasts. The law-making time lag refers to the point that after all the Congressional debate is concluded and the act is finally signed into law, the lag involved means that the economy might no longer be in recession. The shrinking area of law-maker discretion points out that more and more of the government budget is "out of bounds" for change. For instance, the government is highly unlikely in the near future to decrease expenditure on Social Security. As the budget includes more of these "untouchables," there is less room left for changes needed for fiscal policy. The problem with estimating potential GDP means that the recession might be less severe than believed. As a result, fiscal policy might be too strong and although it eliminates the recession, the fiscal policy might increase real GDP so much that it moves the economy farther away from potential GDP. Finally, the difficulty making economic forecasts means that forecasters cannot be sure what will be the state of the economy when the fiscal policy is finally implemented. If the economy is naturally recovering from the recession and this recovery is not forecast, then when the fiscal policy is implemented, the policy might push the economy well past potential GDP.

"The federal budget is required by law to balance." Is the previous statement correct or incorrect?

The statement is incorrect because the federal budget is not legally required to balance. It is legal for the government to run a budget surplus or a budget deficit.

"Discretionary fiscal policy is a fiscal action initiated by an act of the Federal Reserve, while automatic fiscal policy is a fiscal action induced by the state of the economy." Is the previous statement correct or incorrect? Explain your answer.

The statement is incorrect. The statement is correct about automatic fiscal policy. But it is incorrect about discretionary fiscal policy because discretionary fiscal policy is not initiated by the Federal Reserve—it is initiated by an act of Congress.

Explain the role the Fed, Congress, and the President play in making monetary policy.

Ultimately the Federal Reserve maintains responsibility for setting monetary policy in the United States. The Federal Reserve Act gives the Board of Governors and Federal Open Market Committee responsibility to conduct monetary policy. The FOMC meets eight times a year to make monetary policy decisions. The Congress does not play a role in setting monetary policy. However, the Board of Governors is required to report on monetary policy and actions to Congress as laid out in the Federal Reserve Act. The President of the United States has a limited role in monetary policy. The President appoints members to the Board of Governors of the federal Reserve and also appoints the Chair of the Board of Governors.

Explain how tax revenue can be both an automatic fiscal policy and a discretionary fiscal policy.

When Congress changes the tax law, it is a discretionary policy. For any given set of tax laws, a change in the state of the economy will automatically change the tax revenue. Hence for a given set of tax laws, tax revenues operate as an automatic fiscal policy.

When government outlays exceed tax revenues, does the government have a budget deficit or surplus?

When government outlays exceed tax revenues, the government is running a budget deficit.

Discuss how the Fed selling securities in the open market ripples through the different sectors of the economy.

When the Fed sells securities in the open market it raises the federal funds rate. Banks' reserves decrease, in turn decreasing the quantity of money. The supply of loanable funds decreases so the real interest rate rises. The higher real interest rate decreases investment and consumption expenditure, especially consumption expenditure on durable goods. In the foreign exchange market, the higher interest rates increase the attractiveness of U.S. securities. Foreigners increase their demand for U.S. dollars in order to purchase these securities and so the price of the dollar rises on the foreign exchange market. The rise in the price of the dollar makes exports more expensive to foreigners and imports less expensive to U.S. residents. As a result, exports decrease and imports increase so that net exports decrease. All of the changes decrease aggregate demand.

The interest rate banks charge each other on loans of reserves is called the

federal funds rate.

The monetary policy instrument the Federal Reserve chooses to use is the

federal funds rate.

If the government uses fiscal policy to close a recessionary gap,

government expenditure can be increased by less than the gap because of the government expenditure multiplier.

The magnitude of the tax multiplier is ________ the magnitude of the government expenditure multiplier.

smaller than