Chapter 16

•Timing fiscal policy is harder, due to:

-Legislative delay -Implementation delay

​One-time tax​ rebates, such as those in 2001 and​ 2008, increase consumption spending by less than a permanent tax cut because​ one-time tax rebates increase A. current income. B. the multiplier effect. C. taxable income. D. permanent income.

A

If Congress and the president decide an expansionary fiscal policy is​ necessary, what changes should they make in government spending or​ taxes? A. In this​ case, Congress and the president should enact policies that decrease government spending and decrease taxes. B. In this​ case, Congress and the president should enact policies that increase government spending and increase taxes. C. In this​ case, Congress and the president should enact policies that increase government spending and decrease taxes. D. In this​ case, Congress and the president should enact policies that decrease government spending and increase taxes.

C

When is it considered​ "good policy" for the government to run a budget​ deficit? A. When borrowing is used for current expenses. B. When borrowing is used to pay for social insurance programs. C. When borrowing is used for​ long-lived capital goods. D. All of the above.

C

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? A. The dynamic model assumes that potential GDP is constantly growing while the basic model assumes that it is static. B. If the economy is below full​ employment, expansionary fiscal policy will cause an increase in the price level in both models. C. In the dynamic​ model, expansionary policy would be used when demand does not grow​ sufficiently; in the basic​ model, expansionary policy would be used when demand falls. D. All of the above are correct statements about the two models. E. None of the above are correct statements about the two models.

D

Who is responsible for fiscal​ policy? A. The federal government and the Federal Reserve jointly control fiscal policy. B. Fiscal policy is controlled by market forces. C. The Federal Reserve controls fiscal policy. D. The federal government controls fiscal policy.

D

-Congress needs to agree on the actions

Legislative delay

The process by which a change in autonomous expenditure leads to a larger change in real G D P.

Multiplier effect

is the situation in which the government's expenditures are less than its tax revenue.

budget surplus

involves decreasing government purchases or increasing taxes.

contractionary fiscal policy

•Affects the incentives of firms to engage in investment.

corporate income tax

A change in government purchases ______ affects aggregate demand.

directly

on the other hand, refers to intentional actions the government takes to change spending or taxes.

discretionary fiscal policy

of individuals and firms to take part in economic activities, generally resulting in lower levels of economic activity—lower real G D P.

distorts the incentives

consist of defense spending and "everything else," like salaries of F B I agents, operating national parks, and funding scientific research.

federal government purchases

To judge the effect of the stimulus package, we have to measure its effects

holding constant all other factors affecting real G D P and employment.

A change in taxes changes income; this in turn affects consumption, and so it has an _________ effect on aggregate demand.

indirect

Affects labor supply decisions and returns to entrepreneurship

individual income tax

But then people receive this increased spending as increased income, increasing their consumption spending accordingly. This is the

induced increase in aggregate demand.

A decrease in government purchases and an increase in taxes have a __________ multiplier effect

negative

An increase in government purchases and a cut in taxes have a _______ multiplier effect.

positive

The higher the tax​ rate, the _______ the multiplier effect.

smaller

it assumes long-run potential G D P does not change, and that the price level is constant.

the fiscal policy is static

Congress and the president carry out fiscal policy through:

•Changes in government purchases •Changes in taxes

For now, the federal government is at no serious risk of defaulting on its obligations, because:

•The interest rate it can borrow money at is very low •The size of the interest payments on the debt is low relative to the size of the federal budget—around 11 percent

•Problem: Recession•Policy: Expansionary•Actions: ^ Gov't Spending or 1_______•Result: Real GDP and price level 2____•Problem: Rising inflation•Policy: Contractionary•Actions: 3_______ or ^ Taxes•Result: Real GDP and price level 4_____

1. Decrease Taxes2. rise3. Decrease gov't spending4. fall

Decreases in tax rates have a slightly different effect:

1.Increasing the disposable income of households, leading them to increase their consumption spending 2.Increasing the size of the multiplier effect, since more of any increase in income becomes disposable income.

The long-run growth rate of real G D P depends primarily on:

1.The growth in the number of hours worked 2.The growth rate of labor productivity as measured by the growth in real G D P per hour worked.

What changes should they make if they decide a contractionary fiscal policy is​ necessary? A. In this​ case, Congress and the president should enact policies that decrease government spending and increase taxes. B. In this​ case, Congress and the president should enact policies that increase government spending and decrease taxes. C. In this​ case, Congress and the president should enact policies that increase government spending and increase taxes. D. In this​ case, Congress and the president should enact policies that decrease government spending and decrease taxes.

A

As a result of crowding out in the short​ run, the effect on real GDP of an increase in government spending is often A. more than the increase in government spending. B. less than the increase in government spending. C. equal to the increase in government spending. D. unrelated to the increase in government spending.

B

Policy that is specifically designed to affect aggregate supply and increase incentives to​ work, save, and start a​ business, by reducing the tax wedge is called A. labor economics. B. ​supply-side economics. C. ​demand-side economics. D. ​tax-and-spend economics.

B

What is the difference between federal government purchases​ (spending) and federal government​ expenditures? A. Government expenditures are included in government purchases. B. Government purchases are included in government expenditures. C. Government purchases refer to spending for which no good or service is received. D. They are the same.

B

What is the difference between federal government purchases​ (spending) and federal government​ expenditures? A. Government purchases refer to spending for which no good or service is received. B. Government purchases are included in government expenditures. C. Government expenditures are included in government purchases. D. They are the same.

B

After September​ 11, 2001, the federal government increased military spending on wars in Iraq and Afghanistan. Is this increase in spending considered fiscal​ policy? A. Yes. Fiscal policy refers to changes in government spending and taxes. B. Yes. Increases in defense spending are designed to achieve macroeconomic policy objectives. C. No. The increase in defense spending after that date was designed to achieve homeland security objectives. D. No. Fiscal policy refers to changes in interest rates and the money supply.

C

Does government spending ever reduce private​ spending? A. ​No, they are unrelated. B. ​Yes, due to reduced interest rates. C. ​No, due to crowding out. D. ​Yes, due to crowding out.

D

How does a budget deficit. act as an automatic stabilizer and reduce the severity of a​ recession? A. Consumers spend more than they would in the absence of social insurance​ programs, like unemployment. B. Transfer payments to households increase. C. During​ recessions, tax obligations fall due to falling wages and profits. D. All of the above.

D

What are the gains to be had from simplifying the tax​ code? A. Greater clarity of the decisions made by households and firms. B. Resources from the tax preparation industry freed up for other endeavors. C. Increased efficiency of households and firms. D. All of the above.

D

What are the gains to be had from simplifying the tax​ code? A. Resources from the tax preparation industry freed up for other endeavors. B. Greater clarity of the decisions made by households and firms. C. Increased efficiency of households and firms. D. All of the above.

D

What is fiscal​ policy? A. Fiscal policy can be described as changes in government spending and interest rates to achieve macroeconomic policy objectives. B. Fiscal policy can be described as changes in interest rates and taxes to achieve macroeconomic policy objectives. C. Fiscal policy can be described as changes in interest rates to achieve macroeconomic policy objectives. D. Fiscal policy can be described as changes in government spending and taxes to achieve macroeconomic policy objectives.

D

Which can be changed more​ quickly: monetary policy or fiscal​ policy? A. Monetary policy can be changed more quickly than fiscal policy. Fiscal policy can be changed at any of the FOMC meetings and the smaller number of individuals involved makes it easier to change policy. B. Fiscal policy can be changed more quickly than monetary policy. Monetary policy has much longer delays due to the larger number of legislators involved. C. Fiscal policy can be changed more quickly than monetary policy. Fiscal policy has much shorter delays due to the smaller number of legislators involved. D. 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.

D

involves increasing government purchases or decreasing taxes.

Expansionary fiscal policy

Budget deficits also occur during recessions, as tax receipts fall, and _____________ like increases in transfer payments (unemployment insurance, food stamps, etc.) take effect.

automatic stabilizers

Some forms of government spending and taxes automatically increase or decrease along with the business cycle; these are

automatic stabilizers

If the government increases its spending on goods and services, then aggregate demand increases immediately. This is the

autonomous increase in aggregate demand.

is the situation in which the government's expenditures are greater than its tax revenue.

budget deficit

•Government spending might ________ private spending

crowd out

A decline in private expenditures as a result of an increase in government purchases.

crowding out

What is the cyclically adjusted budget deficit or​ surplus? A. The cyclically adjusted budget deficit or surplus is the deficit or surplus in the federal​ government's budget if the economy were above potential GDP. B. The cyclically adjusted budget deficit or surplus requires the federal budget to always be in​ balance, therefore avoiding a deficit or surplus. C. The cyclically adjusted budget deficit or surplus is the deficit or surplus in the federal​ government's budget if the economy were below potential GDP. D. The cyclically adjusted budget deficit or surplus is the deficit or surplus in the federal​ government's budget if the economy were at potential GDP. Suppose that the economy is currently at potential​ GDP, and the federal budget is balanced. If the economy moves into​ recession, what will happen to the federal​ budget? A. If the budget is balanced at potential GDP and the economy moves into​ recession, then the budget will remain balanced as government expenditure decreases and tax revenue decreases will exactly offset each other. B. If the budget is balanced at potential GDP and the economy moves into​ recession, then the budget will remain balanced as government expenditure increases and tax revenue decreases will exactly offset each other. C. If the budget is balanced at potential GDP and the economy moves into​ recession, then there will be a budget deficit as government expenditures increase and tax revenues decrease. D. If the budget is balanced at potential GDP and the economy moves into​ recession, then there will be a budget deficit as government expenditures decrease and tax revenues increase.

D, C

The multiplier effect is only a consideration for increases in government purchases. T or F

False

-Large spending projects may take months or even years to begin, even once approved.

Implementation delay

•Affects the supply of loanable funds from households to firms and hence the real interest rate. •Also affects the way firms disburse profits—2003 reduction in dividend tax led some firms like Microsoft to pay dividends for the first time.

Tax on dividends and capital gains

But other fiscal policy actions are intended to have long-run impacts on potential G D P—i.e. on _________ rather than ___________

aggregate supply, aggregate demand

When an individual decides how much to work, he bases the decision on how much an hour of work will increase his ability to consume goods and services—the

posttax wage

When a firm decides how many people to employ, it considers how much it has to pay in total for each worker: the

pretax

When is it considered​ "good policy" for the government to run a budget​ deficit? A. When borrowing is used for​ long-lived capital goods. B. When borrowing is used for current expenses. C. When borrowing is used to pay for social insurance programs. D. All of the above.

A

Why does a​ $1 increase in government purchases lead to more than a​ $1 increase in income and​ spending? A. 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. B. Through the government purchases​ multiplier, the​ $1 increase in government spending will lead to a decrease in aggregate demand and national​ income, which will lead to an increase in induced spending. C. 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 a decrease in induced spending. D. Through the government purchases​ multiplier, the​ $1 increase in government spending will lead to a decrease in aggregate demand and national​ income, which will lead to a decrease in induced spending.

A

In what ways does the federal budget serve as an automatic stabilizer for the​ economy? A. During a​ recession, there is an increase in government expenditures for transfer payments and a decrease in taxes as wages and profits rise. During an​ expansion, there is a decrease in government expenditures for transfer payments and an increase in taxes as wages and profits fall. Both of these occur automatically and both effects help to stabilize aggregate demand. B. During a​ recession, there is an increase in government expenditures for transfer payments and a decrease in taxes as wages and profits fall. During an​ expansion, there is a decrease in government expenditures for transfer payments and an increase in taxes as wages and profits rise. Both of these occur automatically and both effects help to stabilize aggregate demand. C. During a​ recession, there is a decrease in government expenditures for transfer payments and an increase in taxes as wages and profits rise. During an​ expansion, there is an increase in government expenditures for transfer payments and a decrease in taxes as wages and profits fall. Both of these occur automatically and both effects help to stabilize aggregate demand. D. During a​ recession, there is an increase in government expenditures for transfer payments and a decrease in taxes as wages and profits fall. During an​ expansion, there is a decrease in government expenditures for transfer payments and an increase in taxes as wages and profits rise. Both of these require government action to stabilize aggregate demand.

B

Briefly explain whether an expansionary fiscal policy will cause each of the following variables to increase or​ decrease: ​(i) Real GDP A. Not affect real GDP because potential GDP​ won't change. B. Decrease real GDP by decreasing​ long-run aggregate supply. C. Increase real GDP by increasing aggregate demand. D. Increase real GDP by increasing​ short-run aggregate supply. ​(ii) The unemployment rate A. Decrease the unemployment rate by decreasing the labor force. B. Decrease the unemployment rate by increasing production. C. Increase the unemployment rate by increasing wages. D. Increase the unemployment rate by decreasing employment. ​(iii) The price level A. Increase the price level because less is supplied. B. Decrease the price level because inflation falls. C. Decrease the price level because more is supplied. D. Increase the price level because more is demanded.

C, B, D

Increased government debt can lead to higher interest rates​ and, as a​ result, crowding out of private investment spending. In terms of borrowing​ (debt-spending), what will offset the effect of crowding out in the long run so that government debt poses less of a problem to the​ economy? A. ​Debt-spending on highways and ports. B. ​Debt-spending on research and development. C. ​Debt-spending on education. D. All of the above.

D

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? A. The basic model assumes that potential GDP is constantly growing while the dynamic model assumes that it is static. B. In the dynamic​ model, contractionary policy would be used when demand grows too​ slowly; in the basic​ model, expansionary policy would be used when demand increases. C. If the economy is above full​ employment, contractionary fiscal policy will reduce the inflation rate in the basic but not the dynamic model. D. All of the above are correct statements about the two models. E. None of the above are correct statements about the two models.

E

refers to changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives.

Fiscal policy

Problem: Rising inflation Policy: Actions by Congress and the President: Result:

Problem: Inflation Policy: Contractionary Actions by Congress and the President: Decrease government purchases or raise taxes Result: Real GDP and price fall

Problem: Recession Policy: Actions by Congress and the President: Result:

Problem: Recession Policy: Expansionary Actions by Congress and the President: Increase government purchases or cut taxes Result: Real GDP and price rise

The sum of the growth rate of hours worked and the growth rate of labor productivity

Real GDP

The tax multiplier applies to changes in the amount of taxes, without changes in

tax rates

the difference between the pretax and posttax return to an economic activity.

tax wedge