ECON131 Chapter 10: Fiscal Policy and Debt

How large is the government's budget deficit if asset sales are $200 billion, the money supply grows by $500 billion, the government sells $1 trillion in bonds, and tax revenues are $500 billion?

$1.7 trillion

If Amanda has an income of $40,000 and disposable income of $30,000, how much does she pay in taxes?

$10,000

Fiscal Sustainability

A measure of the present value of all projected future revenues compared to the present value of projected future spending

As baby boomers keep retiring in coming years, it is likely that fiscal imbalance will . . .

worsen.

Tony just purchased a Treasury note. How long will it take for that Treasury note to reach maturity?

1 to 10 years

Crowding-Out Effect

Arises from deficit spending requiring the government to borrow, thus driving up interest rates and reducing consumer spending and business investment

What does it mean that the income tax is progressive?

As income increases, the income tax rate increases.

Cyclically Balanced Budget

Balancing the budget over the course of the business cycle by restricting spending or raising taxes when the economy is booming and using these surpluses to offset the deficits that occur during recessions

Functional Finace

Essentially ignores the impact of the budget on the business cycle and focuses on fostering economic growth and stable prices, while keeping the economy as close as possible to full employment

Suppose policymakers wish to use fiscal policy to fight inflation. Which statement is MOST accurate?

Essentially, the way to lower the inflation rate is to decrease aggregate demand and cause a recession.

Annually Balanced Budget

Federal expenditures and taxes would have to be equal each year

Discretionary Fiscal Policy

Involves adjusting government spending and tax policies with the express shortrun goal of moving the economy toward full employment, expanding economic growth, or controlling inflation

Expansionary Fiscal Policy

Involves increasing government spending, increasing transfer payments, or decreasing taxes to increase aggregate demand to expand output and the economy

Contractionary Fiscal Policy

Involves increasing withdrawals from the economy by reducing government spending, transfer payments, or raising taxes to decrease aggregate demand to contract output and the economy

Supply-Side Fiscal Policies

Policies that focus on shifting the long-run aggregate supply curve to the right, expanding the economy without increasing inflationary pressures. Unlike policies to increase aggregate demand, these policies take longer to have an impact on the economy.

Externally Held Debt

Public debt held by foreigners, which is roughly equal to half of the outstanding U.S. debt held by the public

Internally Held Debt

Public debt owned by U.S. banks, corporations, mutual funds, pension plans, and individuals

___ government spending, ___ transfer payments, and ___ taxes are all examples of contractionary fiscal policy.

Reducing; reducing; raising

Surplus

The amount by which annual tax revenues exceed government expenditures

Laffer Curve

Shows a hypothetical relationship between income tax rates and tax revenues. As tax rates rise from zero, revenues rise, reach a maximum, then decline until revenues reach zero again at a 100% tax rate.

In 2012, more than 40% of federal government spending was on . . .

Social Security, Medicare, and Medicaid (Mandatory Spending).

The largest category of federal government spending in 2012 was . . .

Social Security.

Mandatory Spending

Spending authorized by permanent laws that do not go through the same appropriations process as discretionary spending and includes such programs as Social Security, Medicare, and interest on the national debt

Automatic Stabilizers

Tax revenues and transfer payments automatically expand or contract in ways that reduce the intensity of business fluctuations without any overt action by Congress or other policymakers

Deficit

The amount by which annual government spending exceeds tax revenues

Public Choice Theory

The economic analysis of public and political decision making, looking at issues such as voting, the impact of election incentives on politicians, the influence of special interest groups, and rent-seeking behaviors

Which of the following groups must agree in order to implement fiscal policy?

the Senate, House of Representatives, and executive branch

Government Budget Restraint

The government budget is limited by the fact that G − T = ΔM + ΔB + ΔA

Discretionary Spending

The part of the budget that works its way through the appropriations process of Congress each year and includes such programs as national defense, transportation, science, environment, and income security

Decision Lag

The time it takes Congress and the administration to decide on a policy once a problem is recognized

Recognition Lag

The time it takes for policymakers to confirm that the economy is in a recession or a recovery. Short-term variations in key economic indicators are typical and sometimes represent nothing more than randomness in the data.

Information Lag

The time policymakers must wait for economic data to be collected, processed, and reported. Most macroeconomic data are not available until at least one quarter (three months) after the fact.

Implementation Lag

The time required to turn fiscal policy into law and eventually have an impact on the economy

Public Debt

The total accumulation of past deficits less surpluses. It includes Treasury bills, notes, and bonds, and U.S. Savings Bonds.

According to the Laffer curve, an increase in tax rates will lead to . . .

an increase, a decrease, or no change in tax revenue.

The government's budget deficit is financed by . . .

asset sales and bond sales.

Presidents Kennedy and Reagan each implemented a policy of supply-side economics. What did this mainly entail?

They decreased marginal tax rates. President Kennedy reduced the top marginal rate from 70% to 50%, and President Reagan reduced the top marginal rate from 50% to 28%.

In 2012, 51.4% of the national debt held by the public was owned by . . .

U.S. banks, corporations, mutual funds, pension plans, and individuals.

What item is NOT public debt?

U.S. dollars

When workers lose their job, they file for unemployment benefits, so government spending on such programs naturally rises during recessions. As the economy recovers and people go back to work, spending on unemployment programs shrinks. Which of the following is CORRECT?

Unemployment compensation is a form of automatic stabilizer.

Which of the following will NOT help the government pay for a rising budget deficit?

buying

Which of the following is a description of an automatic stabilizer of the business cycle?

When the economy is in decline, transfer payments increase. Transfer payments increase when the economy is in decline because incomes are falling and people are more reliant on income security programs.

If a government collects $1,400 in tax revenue and spends $1,600, it has . . .

a deficit of $200.

The solution to simultaneous deflation and unemployment is to shift the . . .

aggregate demand curve to the right.

In 2009, the percentage of the publically held national debt owned by foreigners was . . .

almost equal to the percentage held by the U.S. public.

After the elections of 2010, the U.S. Senate remained controlled by the Democrats, but the majority of the House of Representatives became Republican. Associated with fiscal policy, you might expect that this would increase the . . .

decision lag.

The main tool of supply-side economics is . . .

decreasing marginal tax rates.

In 2012, 48.6% of the national debt was held by . . .

foreigners.

In February 2009, Congress approved a $787 billion stimulus package. By March 30, 2011, $633.5 had been spent. This illustrates . . .

implementation lag.

The goal of expansionary fiscal policy is to . . .

increase aggregate output (by putting more money into the hands of consumers and businesses) in order to escape a recession.

Which of the following policies do supply-side economists believe is the best for increasing the standard of living?

increasing investment in capital that boosts worker productivity

The largest source of federal government revenues is . . .

individual income taxes.

An expansionary fiscal policy can result in . . .

inflation and higher GDP.

Modern growth theory suggests that government should focus on _____ to create economic growth.

investments in human capital

According to public choice theorists, deficit spending . . .

is undertaken as a politically palatable way of funding programs.

The focus of supply-side fiscal policies is on . . .

long-run economic growth.

Treasury bonds have maturity periods that are . . .

longer than ten years.

Treasury notes mature in . . .

one to ten years.

Treasury bills will mature in . . .

one year or less.

Economists who favor the functional finance approach to the federal budget believe that . . .

policymakers should work to keep the economy at full employment with stable prices. Whether the budget is in surplus or deficit is a secondary concern.

In September 2010, the National Bureau of Economic Research announced that the recession that began in December 2007 ended in June 2009. This illustrates . . .

recognition lag.

Policymakers realize the economy is in a recovery several quarters after it started. This is a description of the . . .

recognition lag.

The crowding out effect recognizes that if the government sells bonds to finance spending, it can cause interest rates to ___________ investment.

rise, reducing

Which of the following methods of government deficit finance is MOST likely to crowd out private investment?

selling bonds to banks