Chapter 10- Fiscal policy, economic growth, and productivity`

What is investment tax credit?

A reduction in taxes for firms that invest in new capital like a factory or piece of equipment

When the government uses contractionary fiscal policy do they create a surplus or deficit?

A surplus

What are the two ways to finance a deficit? (How does gov finance a deficit)

Borrowing Creating money

What is the second way a government can overcome its deficit?

By creating money

What is the second choice a government has to handle a budget surplus in contractionary fiscal policy?

DO nothing

What is contractionary fiscal policy doing?

Decreases in government spending or higher net taxes meant to shift the aggregate expenditure function downward and shift AD to the left. increasing taxes decreasing transfer payments

Fiscal policy

Deliberate changes in government spending and net tax collection to affect economic output, unemployment, and the price level.

What creates a budget deficit?

Exists when government spending exceeds the revenue collected from taxes.

What creates a budget surplus?

Exists when the revenue collected from taxes exceeds government spending.

When financing a deficit what do you weaken?

Expansionary fiscal policy

What is supply-side fiscal policy?

Fiscal policy centered on tax reductions targeted to AS so that real GDP increases with very little inflation. The main justification is that lower taxes on individuals and firms increase incentives to work, save, invest, and take risks.

When an economy is in a recession what is real GDp and unemployment like?

GDP is low Unemployment is high

What is the effectiveness of the contractionary fiscal policy dependent on?

How they handle the surplus

However, you need US dollars to invest when interest rates go up and aliens invest. So what does this do to US dollars in demand?

Increases demand of dollar and drives the price of the dollar up.

When the government borrows funds what will they have to pay back the money with?

Interest

When net exports falls what happens to aggregate demand?

It decreases

When using contractionary fiscal policy what happens to inflation?

It goes down.

When demand for loanable funds increase what happens to interest?

It increases

When the government borrows in expansionary policy to reduce the deficit what happens to loanable demands?

It increases

If interest rates increase then what happens to investment from foreign countries?

It increases because they make more interest if they are to incest it.

When a government borrows money to finance a deficit what market do they then enter?

Market for loanable funds

When do contractionary policy does GDP decrease a lot?

No

What are the two ways the government can handle a surplus?

Pay down debt

What do they lead to during deficits and surpluses in respective orders?

Recession and econ growth

You use expansionary during what time?

Recessionary gap. GDP is operating below full employment.

What are net taxes?

Tax revenues- transfer payments

What is classical economic theory?

The belief that the economy self corrects and government intervention will do more harm than good

What is keynesian economic theory?

The belief that the government should actively manipulate the economy to reach full employment

What happens when the government pays down debt in the contractionary fiscal policy to handle a surplus?

The demand for loanable funds decrease, because bonds retire, this decreases interest rates. Which then stimulates investment and consumption and counters contractionary fiscal policy. IT also lessens downward affects on price level

What happens to automatic stabilizers during a recessionary period?

The stabilizers increase a deficit by decreasing taxes.

What happens to automatic stabilizers during an inflationary period?

The stabilizers increase budget surplus by increasing taxes.

When demand for loanable funds increase what happens to private investment opportunities?

They decrease because people can no longer afford to invest.

When the dollar appreciates, gets more value, what happens to net exports?

They fall

What happens when the government does nothing when they have a budget surplus in a contractionary fiscal policy?

They move surplus funds out of the economy. This prevents the cash from being recirculated and the anti-inflationary fiscal policy is more effective.

How is national debt accumulated?

Through not paying off a budget deficit

To get a tax cut what must be larger than the other? a.) tax cut> gov spending b.) gov spending> tax cut

a.

Who does the government borrow from? 3

public, banking system, foreign lenders

IF the government is using tax cuts, rather than government spending to expand the economy, what is the mutiplier like?

smaller

What way does expansionary fiscal policy shift aggregate demand?

upward

What is fiscal policy designed to manipulate?

Aggregate demand

How does borrowing to finance the deficit slow down the expansion and what is the name for this?

By increasing interest rates and crowding out.

What are the two theories of fiscal policy?

Classical economic theory Keysenian economic theory

If inflation is a problem what fiscal policy do you use?

Contractionary fiscal policy

Explain crowding out

Government is in a recessionary period so to get the economy moving they increase aggregate demand by increasing government spending or decreasing taxes. Yet, when government spending is greater than the taxes they receive they are in a budget defecit. SO in the deficit the method they choose to get out of the deficit is borrowing money from banks, foreign markets, public etc. Yet, when the government decides to borrow, they transfer to the market of loanable funds. Thus when the government borrows money they increase the interest rate because they increase demanded loanable funds. With the increase of demand of loanable funds interest rates shoot up. The interest rates shooting up then crowds out the public or private borrowers because they cannot afford these interest rates. Thus, since they are not able to invest in the market C and I will decrease and this dampens the effect of expansionary policy.

Fill in the blanks. If government ________ spending w/o increasing taxes they ___________ the annual deficit and national debt

Increase and increase

What is expansionary fiscal policy?

Increase in government spending Lower net taxes (Gross income- taxes paid)

When the government borrows something what happens to the real rate of interest?

It increases.

How does the creation of money hurt economy?

It risks inflation which lessens the effectiveness of expansionary monetary policy.

When aggregate demand decreases what does it do to expansionary fiscal policy?

It weakens it.

What is an automatic stabilizer?

Mechanisms built into a tax system that regulate, or stabilize the macroeconomy as it moves through the business cycle by changing net taxes collected by the government.

If the government borrows money to conduct fiscal policy what happens to interest rates?

They increase

How do automatic stabilizers affect business cycle swings?

They lessen them

What is likely to create a budget deficit?

When the government spends more, or collects less taxes.