ECON 112
What is the cyclically adjusted budget deficit or surplus?
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.
What is the difference between the federal budget deficit and federal government debt?
The federal budget deficit is the year-to-year short fall in tax revenues relative to government spending (T < G + TR), financed through government bonds. The federal government debt is the accumulation of all past deficits.
Who is responsible for fiscal policy?
The federal government controls fiscal policy.
Westville, a small developed country, is experiencing a very high rate of inflation. Roma Anderson, a market research analyst, thinks that the high level of inflation is due to an acute shortage of goods available in the economy. According to her, the government should use expansionary fiscal policies to boost the economy. Meanwhile, Robert Simpson, a member of the finance ministry, is of the opinion that the high level of inflation is the result of excessive household spending. He suggests that the government should increase personal income tax rates to curb consumption demand. Which of the following, if true, will strengthen Robert's claim that high consumer spending is the cause of high inflation?
There is consensus among leading economists and industry experts that the output gap in Westville is currently negative.
Why does a $1 increase in government purchases lead to more than a $1 increase in income and spending?
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.
Why do few economists argue that it would be a good idea to balance the federal budget every year?
To keep a balanced budget during a recession, taxes would have to increase and government expenditures would have to decrease, which would further reduce aggregate demand and deepen the recession.
According to a study by Kanishka Misra of the University of Michigan and Paolo Surico of the London Business School, "Almost half of American families did not adjust their consumption following receipt of the ... 2008 tax rebate." Source: Kanishka Misra and Paolo Surico, "Consumption, Income Changes, and Heterogeneity: Evidence from Two Fiscal Stimulus Programs," American Economic Journal: Macroeconomics, Vol. 6, No. 4, October 2014, pp. 84-106. In general, we expect that people will increase their consumption The 2008 tax cut made it more likely that people would not respond by increasing their consumption spending because it was a
if their disposable income increases one-time tax cut that affected current, not permanent, income.
Writing in the Wall Street Journal, Martin Feldstein, an economist at Harvard University, argues that: "behavioral responses" of taxpayers to the cuts in marginal tax rates enacted in 1986 resulted in "an enormous rise in the taxes paid, particularly by those who experienced the greatest reductions in marginal tax rates." Source: Martin Feldstein, "The Tax Reform Evidence from 1986," Wall Street Journal, October 24, 2011. Cuts in marginal tax rates will What does Feldstein mean by a "behavioral response" to tax cuts? The behavioral response will be that people in
increase marginal net-of-tax income, increase the supply of labor and increase total taxes as people work longer hours. higher tax brackets will experience an increase in taxable income and thus will work more.
In a closed economy, increase in government borrowing are likely to: The result of increased government borrowing in a closed economy is likely to be: In an open economy like the United States, the government has increased borrowing significantly without causing these effects because:
increase the interest rate reductions in investment and purchases of consumer durable goods the U.S. can borrow from savers abroad
When you pay required Social Security taxes from your paycheck, the money goes to:
someone who is receiving Social Security now
As the tax rate increases,
the multiplier effect decreases
The goal of expansionary fiscal policy is
to decrease aggregate demand
Suppose the government increases expenditures by $12120 billion and the marginal propensity to consume is 0.880. By how much will equilibrium GDP change? The change in equilibrium GDP is:
$600 billion
The graph to the right illustrates the static AD-AS model. Suppose the economy is initially in long-run equilibrium at point A. The government decides to increase taxes. In the short-run, this contractionary fiscal policy will cause:
A shift from AD2 to AD1 and a movement to point D, with a lower price level and lower output
What is the "tax wedge"?
A tax wedge is the difference between the pretax and posttax return to an economic activity. For example, a tax on interest income would decrease the posttax return to investment.
What is fiscal policy?
Fiscal policy can be described as changes in government spending and taxes to achieve macroeconomic policy objectives
The term "crowding out" refers to a situation where:
Government spending increases interest rates and decreases private investment.
An article in the Wall Street Journal discussing the Trump administration's goal of increasing the annual rate of growth in real GDP to 3 percent noted that: "Two stubborn obstacles stand in his way. The work force isn't producing enough new workers, and the productivity of those working isn't growing fast enough." Source: Nick Timiraos and Andrew Tangel, "Can Trump Deliver 3% Growth? Stubborn Realities Stand in the Way," Wall Street Journal, May 15, 2017. Which of the following equations explains the reasoning behind this statement? The number of new workers directly affects
Growth rate of real GDP =Growth rate of hours worked+Growth rate of labor productivity. the number of hours worked.
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?
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.
Consider the figure to the right. An increase in government spending shifted the aggregate demand curve from AD 1 to AD 2.As a result, both price level and real GDP increased. What can be said, however, about the increase in real GDP?
It increased by less than indicated by a multiplier with a constant price level.
A policy of cutting the corporate income tax to increase investment spending is intended to result in:
Long run supply side effects
The federal government collected less in total individual income taxes in 1983 than in 1982. Can we conclude that Congress and the president cut individual income tax rates in 1983?
No. It could be that the economy contracted, so less income was earned and less was paid in tax.
After September 11, 2001, the federal government increased military spending on wars in Iraq and Afghanistan. Is this increase in spending considered fiscal policy?
No. The increase in defense spending after that date was designed to achieve homeland security objectives.
What is meant by supply-side economics?
Supply-side economics refers to the use of taxes to increase incentives to work, save, invest, and start a business in order to increase long-run aggregate supply.
In the long run, government tax policy can affect private investment which impacts the production function and factors of production. In other words, aggregate supply may be impacted by different types of taxes the government can use. Which of the following is not true in terms of potential long run impacts of tax policies?
A tax rebate given one year will cause people to have more money and therefore they will spend more which will cause an increase in aggregate supply.
Which can be changed more quickly: monetary policy or fiscal policy?
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.
When is it considered "good policy" for the government to run a budget deficit?
When borrowing is used for long-lived capital goods.
When actual GDP is below potential GDP the budget deficit increases because of:
an increase in transfer payments and a decrease in tax revenues
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
current income
_________are spending by the government on goods, services, and factors of production. ________ represent total government spending including goods, services, grants to state and local governments, and transfer payments Since the 1950s, total government expenditures, as a percentage of GDP, have______ and total government purchases, as a percentage of GDP, have _______ The major cause of these trends is
government purchases government expenditures increased decreased there has been major increase in the amount of transfer payments the government makes through programs such as Social Security and unemployment insurance
Wall Street Journal writers Josh Zumbrun and Nick Timiraos published answers to several of their readers' questions regarding the federal government's debt. Two of the questions were: "Why is government debt different from mine?" and "How important is it to pay off this debt?" Source: Josh Zumbrun and Nick Timiraos, "Q&A: What the $18 Trillion National Debt Means for the U.S. Economy," Wall Street Journal, February 1, 2015. Government debt is different from household debt because How important is it to pay off this debt?
households cannot tax to bring in revenue and so will default if they can't make the payments. Not very important if the debt is at a sustainable level, and the interest payments are relatively constant.
As indicated in the chapter, the CBO forecast that real GDP would grow at an average annual rate of 1.9 percent from 2017 to 2027. The Trump administration pledged to raise the growth rate to 3 percent, although some policymakers and economists were skeptical that this goal could be achieved. Yet from 1960 to 1969, real GDP grew at an average annual rate of 4.5 percent. All of the following are factors that make growth rates that high more difficult to achieve today except
increases immigration
Which of the following raises the largest percentage of federal government revenue?
individual income taxes
Some economists argue that because increases in government spending crowd outLOADING... private spending, increased government spending will reduce the long-run growth rate of real GDP. a. This is most likely to happen if the private spending being crowded out is b. In terms of its effect on the long-run growth rate of real GDP, it is likely to matter more if the additional government spending involves
investment spending increases spending on highways and bridges
The graph to the right shows a situation in which the economy was in equilibrium at potential GDP (at point A) when the demand for housing sharply declined. What actions can Congress and the president take to move the economy back to potential GDP?
Increase government spending or decrease taxes.
Suppose the government increases taxes by $330 billion and the marginal propensity to consume is 0.50. By how will equilibrium GDP change?
The change in equilibrium GDP is: $-30.0 billion.
According to the crowding-out effect, if the federal government increases spending, the demand for money and the equilibrium interest rate will ___________, which will cause consumption, investment, and net exports to ___________.
increase; decrease
In The General Theory of Employment, Interest, and Money, John Maynard Keynes wrote this: "If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise...to dig the notes up again... there need be no more unemployment and, with the help of the repercussions, the real income of the community...would probably become a good deal greater than it is." In this statement, Keynes is discussing the important macroeconomic effect called the ........... effect. By repercussions, Keynes means that an initial increase in autonomous expenditures will Keynes appears unconcerned if government spending is wasteful because
-multiplier -change production by an amount greater than the initial increase in autonomous expenditures -it will still lead to an increase in production and employment.
Which of the following is an example of an expansionary fiscal policy? Suppose the government decreases taxes. Use the aggregate demand and aggregate supply model to show the effects of the decrease in taxes on the economy. 1.) Use the line drawing tool to show the effect of the decrease in taxes on the AD or AS curve. Properly label this line. 2.) Use the point drawing tool to show the new short-run equilibrium. Label this point 'B'.
A decrease in taxes.
Which of the following statements about the federal debt is correct?
If the debt becomes very large relative to the economy, then the government may have to raise taxes to high levels or reduce other types of spending to make the interest payments on the debt.
Which of the following accurately defines the government purchases multiplier and the tax multiplier?
The Government purchases multiplier equals (change in equilibrium real GDP)/(change in government purchases) Tax Multiplier equals (change in equilibrium real GDP)/(change in taxes)
If the short-run aggregate supply curve (SRAS) were a horizontal line, what would be the impact on the size of the government purchases and tax multipliersLOADING...?
The impact of the multiplier would be larger if the SRAS curve is horizontal.
U.S. federal government expenditures are comprised of purchases of goods and services (defense spending plus spending on all day-to-day activities), transfer payments, interest payments, and grants to state and local governments. Which of the following statements is true?
Transfer payments are the largest component of the federal budget (about 50%) followed by defense spending (about 20%), while spending on all its day-to-day activities is the smallest component (about 8%).
Is it possible for Congress and the president to carry out an expansionary fiscal policy if the money supply does not increase?
Yes, because fiscal policy and monetary policy are separate things.
Economist Mark Thoma has written, "One of the difficulties in using fiscal policy to combat recessions is getting Congress to agree on what measures to implement. ... Automatic stabilizers bypass this difficulty by doing exactly what their name implies." Source: Mark Thoma, "The Importance of Automatic Stabilizers to the Economy," cbsnews.com, January 25, 2010. Automatic stabilizers are Two examples of automatic stabilizers in the U.S. are Automatic stabilizers can reduce the severity of a recession because, during a recession,
government spending and taxes that automatically increase or decrease along with the business cycle. unemployment insurance payments and the progressive income tax system unemployment payments rise and tax collections fall, providing more spending ability to push the economy back to full employment.
Suppose the government increases expenditures while holding taxes the same. This will............... deficits or................ surpluses. Assume the increase in government expenditures, from above, occurs. As a result of the increase in government expenditures, the The new equilibrium will be The increase in government expenditures will the interest rate, which will cause in private investment spending, and is referred to as
increase decrease money demand curve will shift right where the new money demand curve intersects the original money supply curve increase decrease crowding out
Suppose the government reduces the corporate income tax rate. This will increase the return to firms for investing, which should.... investment and cause....in capital in the long run. Show the long-run effect of this reduction in corporate tax rates on long-run aggregate supply. 1.) Use the line drawing tool to show the effect on long-run aggregate supply. Properly label this line. 2.) Use the point drawing tool to show the new long-run equilibrium on the graph. Label this point 'B'. The long-run impact of a reduction in corporate tax rates would be
increase an increase an increase in long-run potential output while actually reducing inflation
Imagine a graph that shows a situation in which the economy was in equilibrium at potential GDP (at point A) when the demand for housing sharply declined. What actions can Congress and the president take to move the economy back to potential GDP? As a result of the government's actions, the The new equilibrium will be
increase government spending or decrease taxes aggregate demand curve will shift right. where the new aggregate demand curve intersects the original short-run aggregate supply curve, on the long-run aggregate supply curve.
Consider the following statement: "Real GDP is currently $17.7 trillion, and potential real GDP is $17.4 trillion. If Congress and the president would decrease government purchases by $300 billion or increase taxes by $300 billion, the economy could be brought to equilibrium at potential GDP." If government purchases were to decrease by $300 billion or if taxes were increased by $300 billion, the equilibrium level of real GDP would decrease by
more than $300 billion Therefore, the statement above is incorrect
The corporate income tax rate is increased. This is Defense spending is increased. This is The Federal Reserve lowers the target for the federal funds rate. This is Families are allowed to deduct all their expenses for daycare from their federal income taxes. This is The individual income tax rate is decreased. This is
part of a contractionary fiscal policy not part of fiscal policy not part of fiscal policy not part of fiscal policy part of an expansionary fiscal policy
Economists believe that the smaller the tax wedge for any economic activity, such as working, saving, investing, or starting a business,
the more of that economic activity that will occur
A Federal Reserve publication argues that the size of the multiplier "depends on the type of fiscal policy changes in question and the environment in which they are implemented." Source: Daniel J. Wilson, "Government Spending: An Economic Boost?," Federal Reserve Bank of San Francisco Economic Letter, February 6, 2012. In referring to "the type of fiscal policy changes in question," the author recognizes that The type of policy matters for the size of the multiplier because The reference to "the environment in which they are implemented" is a recognition that The size of the multiplier could be affected by how close real GDP is to potential GDP because
the tax multiplier is different from the government purchases multiplier. households may not spend all of the saved taxes when there is a tax cut, but an increase in government spending will increase aggregate demand by the full amount. changes in government spending can be offset or reinforced by monetary policy, and that the impacts will be different at different phases of the business cycle The effects are more positive during recessions than during inflations.
