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Chap 13 Fiscal Policy, Deficits, and Debt

Fiscal Policy
The federal government efforts to keep the economy stable by increasing or decreasing taxes or government spending
Council of Economic Advisers
A three-member body appointed by the president to advise the president on economic policy.
expansionary fiscal policy
An increase in government purchases of goods and services, a decrease in net taxes, or some combination of the two for the purpose of increasing aggregate demand and expanding real output
budget deficit
when the government spends more money than it collects in taxes
contractionary fiscal policy
Fiscal policy used to decrease aggregate demand or supply. Deliberate measures to decrease government expenditures, increase taxes, or both. Appropriate during periods of inflation.
budget surplus
An excess of government receipts over government spending
built in stabilizer
A mechanism that increases government’s budget deficit (or reduces its surplus) during a recession and increases government’s budget surplus (or reduces its deficit) during inflation without any action by policymakers. The tax system is one such mechanism. Ex) Government spending is a built-in stabilizer
progressive tax system
a tax whose average tax rate increases as the taxpayer’s income increases and decreases as the tax payer’s income decreases
proportional tax system
a tax whose average tax rate remains constant as the taxpayer’s income increases or decreases
regressive tax system
a tax whose average tax rate decreases as the taxpayer’s income increases and increases as the taxpayer’s income decreases
cyclically adjusted budget
based on estimates of what government revenue and spending would be if economy were operating at natural level of output and employment. Reflects policy changes not the current stage of business cycle.
cyclical deficit
a federal budget deficit that is caused by a recession and the consequent decline in tax revenues
political business cycle
Attempts by elected officials to manipulate the economy, increasing economic growth and reducing unemployment and inflation around election time, with the goal of improving evaluations of their performance in office.
crowding out effect
the offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending
public debt
All of the money borrowed by the government and not yet repaid, plus the accrued interest on that money; also called the national debt or federal debt
U.S. securities
Interest-bearing obligations of the U.S. government issued by the U.S. Department of the Treasury as a means of borrowing money. There are three types of marketable Treasury securities—bills, notes, and bonds.
external public debt
The portion of the public debt owed to foreign citizens, firms, and institutions
public investments
Governemnt expenditures on public capital (such as roads, highways, bridges, mass transit systems, and electric power facilities) and on human capital (such as education, training, and health).
The US tax system is considered an automatic or ___________
built-in stabilizer
In what kind of tax system does the average tax rate fall as GDP rises?
Regressive tax system
In what kind of tax system does the average tax rate remains constant and GDP rises?
Proportional tax system
In what kind of tax system does the average tax rate rises with GDP
____ can only dampen not eliminate swings in real GDP.
Built-in stabilizers
____ fiscal policy should be shaped to strengthen, or at least not impede, the growth of long-term aggregate supply.
Examples of transfer payments:
Unemployment compensation
Welfare payments
In times of demand-pull inflation, economists typically recommend:
tax increase
A leftward shift of aggregate demand could eliminate a(n) ____ GDP gap, and move the economy’s production to full employment level.
How do cyclically adjusted budget deficits compare in size to actual budget deficits?
They are smaller
Congress and the Bush administration responded to the 2001 recession by passing
tax cuts
___ can only dampen,not eliminate swings in real GDP
Built-in stabilizers
the demand line that is increasing is a ____ relationship
The ownership of public debt is concentrated among wealthier groups and the federal tax system is only slightly progressive then payment of interest on the public debt mildly increases ____ inequality
A large public debt may crowd out capital goods purchases and therefore cause a smaller production capacity from whom?
Future generations
In the immediate short-run, none of the changes in aggregate demand can be dissipated by a change in the price level, because:
aggregate supply is flat
the cyclically adjusted budget reveals the status of US fiscal policy by showing what the federal budget deficit or surplus would have been under existing tax rates and government spending levels if the economy had achieved its ____ level of GDP
The portion of the public debt that is owned by US citizens and institutions is both a(n) ____ to Americans (as taxpayers) and an ____ to Americans (as holders of US government securities.
liability; asset
To whom does the United States owe a substantial portion of the public debt to?
Americans also own ____ issued by foreign governments.
When the US pays the owners of externally held debt, what is the impact on US GDP?
Real GDP will fall
If the cyclically adjusted deficit rises from 1% of GDP to 3%, what is the status of the discretionary fiscal policy?
True or False: The economic cost of WWII was borne almost entirely by those who lived during the war
Dividing total public debt by the population yields a measure of debt per ____
In the short run, an increase in aggregate demand results _____ _____
demand-pull inflation
True or False: A wealthy, highly productive nation would find it more difficult to incur and carry debt than a poor nation can
The US public debt as a percentage of GDP has increased between 2008 and 2009 because of huge budget ___ and a falling real GDP.
Elected officials sometimes cause ____ cycles in their attempts, through fiscal policy actions, to increase their changes of reelection.
political business
During an election period, a politician may favor large tax cuts in order to quickly stimulate the economy to increase reelection hopes. This is an example of what?
Politicians making fiscal policy decisions that may not be economically appropriate.
Potential output reflects an economy with no ____ unemployment
If an economies MPC is 0.75 an increase in government spending by $1.25 billion with a reduction of taxes by %5 billion will produce a targeted $____ billion initial increase in new spending.
Some economists believe that the built-in stability provided by the US ___ system has reduced the severity of business fluctuations by as much as 8%-10% of the change in GDP that would have otherwise occurred.
___ ____ ___ moderate business cycles by increasing the government’s budgets deficit during a recession and increasing its budget surplus during an expansion without requiring explicit action by policymakers.
Built-in automatic stabilizers
_____ ______ automatically occurs during a recession, providing some built-in stability
budget deficit
In 2009 the total public debt was about ____ trillion dollars and was made up of 57% debt held outside the federal government and federal reserve and 43% debt held by the federal government and federal reserve.
When demand-pull inflation occurs as a result of demand outpacing supply, what direction of fiscal policy action is usually taken?
Contractionary fiscal policy
During the Great Depression of the 1930s, most of the increase in federal spending was offset by decreases in ____ and ____ spending.
state; local
An increase in investment demand may counter the decline in investment that would otherwise result from a higher interest rate due to so-called ____ complementaries.
What problems of timing may arise in connection with fiscal policy?
Administrative lags
Operational lags
Recognition lags
Government spending on public works such as dams and interstate highways requires what?
Long planning periods and even longer periods of construction
Discretionary fiscal policy consists of deliberate changes in government spending and taxation designed to do which of the following?
Control inflation
Achieve full employment
Encourage economic growth
The manipulation of taxes and federal spending in order to stimulate the economy or reduce inflation is known as ____ policy.
To positively stimulate the economy using fiscal policy, government spending should ___, and taxes should ____, or both.
rise; fall
The total amount of money owed by the United States Treasury to holders of US securities is the total ___ ___
public debt
Public borrowing drives up real interest rates and does what to private investment spending?
reduces it
All else equal, which of the following are potentially crowded out as a result of expansionary fiscal policy?
Interest-sensitive consumption
When there is a ratchet effect, what happens to the price level when aggregate demand decline?
the price level remains the same
The steps for government to follow in order to correct an inflationary gap without throwing it into a recessionary gap:
1. Take into account the size of the inflationary GDP gap
2. Know that the price level is fixed and the aggregate supply curve is horizontal so the multiplier is in full effect
3. Calculate the effect of the multiplier
4. After applying the multiplier, initiate a change in government spending that accounts for the entire inflationary gap.
When aggregate demand increases, the price level rises. But when aggregate demand decreases, the price level tends to be inflexible. What effect does this describe?
The ratchet effect
Discretionary fiscal policy is also known as what?
Active fiscal policy
Which of the following are used to describe policy changes that occur without congressional action?
The total public debt represents the total amount of money owed by the Federal government to holders of U.S. government
An economy’s potential output is also known as what?
Full-employment output
A recession is a negative GDP gap and increases in ____ will always accompany this gap.
Fiscal tools that government may use to eliminate an inflationary GDP gap?
Decrease government spending
Raise taxes
Use a combination of both
Reduced government spending, in response to demand-pull inflation, shifts the aggregate demand curve to the ___
how does an increase in GDP result in more tax revenue?
As GDP rises, incomes increase
As GDP rises, sales of good and services increase
When GDP declines, tax receipts ____.
What provides the information needed to assess discretionary policy and determine whether it is expansionary, contractionary, or neutral?
Cyclically adjusted budgets
What are reasons that a booming economy leads to high investment demand?
Firms will be adding capacity.
Equipment will wear out quickly and need to be replaced.
The public debt is essentially the total accumulation of federal _____ ____ and ____ ____ that the federal government has incurred over the years.
budget deficit; budget surplus
Which of the following is a potential flaw of fiscal policy?
The crowding out effect
The ____ effect is less likely to be a problem during a recession because investment demand is low during that period.
crowding out
Which are included in the definition of “public” in regards to the holders of federal debt?
Local Governments
State Governments
True or False: Most of the Federal government debt is owed to foreigners.
The debt is held by ____ ____ and ____
US citizens and Foreigners
When an economy’s output is less than its potential output, the gap is known as a ___ gap.
To induce an increase in consumption through a tax-cut, the smaller the MPC is, the ____ the tax-cut needs to be.
Why does the consumption spending rise by $5 billion, and saving by $1.67 billion, if the government cuts taxes by $6.67?
The MPC is 0.75
The MPS is 0.25
A(n) _____ lag occurs between the time fiscal action is taken and the time that action affects output, employment, and the price level.
There will typically be a significant time lag between the need for ____ action is recognized and the time action is taken.
The crowding-out effect may result from ___ fiscal policy.
What are example of government spending on public works projects that require long planning periods and even longer periods of construction?
Education infrastructure
Interstate highways
The economy is often 4-6 months into a recession or inflation before the situation is clearly discernible and this is a result of what?
The recognition lag
Discretionary fiscal policy has increasingly relied on change in ____ rather than on ___ ___ as its main tool because spending is of questionable use in offsetting short periods of recession.
taxes; government spending
The ___ ___ occurs because the economy does not move smoothly through the business cycle.
recognition lag
The ___ ___ is the time between the beginning of a recession or inflation and the certain awareness that it is actually happening.
recognition lag
There will typically be a significant time lag between the need for ___ action is recognized and the time action is taken.
What are reasons that a large US public debt might not threaten to bankrupt the Federal government?
A tax cut must be ____ than a proposed increase in government spending to achieve the same amount of rightward shift in the AD curve
Expansionary fiscal policy is used to do what to the economy?
Stimulate the economy
The government can help correct a recession by implementing expansionary fiscal policy that reduces ____ to increase consumption spending and aggregate demand.
A budget deficit is government spending in excess of what?
tax revenues
What may government choose to combine in order to reduce AD and check inflation?
Spending decreases
Tax increases
Restrictive fiscal policy is also known as ___ fiscal policy.
If there is an increase in taxes of $4 billion in an economy with a MPC of 0.75, by how much will saving be initially reduced?
$1 billion
The government can ___ taxes to shift the AD curve rightward.
A tax increase is a government option for gaining sufficient revenue to pay interest and principal on what?
the public debt.
When portions of the debt come due each month, the government sells new bonds and uses the proceeds to pay holders of the maturing bonds. This exemplifies:
refinancing debt
US public debt or bonds held by foreigners is also known as ____ public debt.
The up-sloping AS curve means that rightward shifts of AD result more in _____ ____ than in increased output.
demand-pull inflation
Government can use what to reduce consumption?
tax increases
A decrease in aggregate demand causes real GDP to _____
When tax revenues are in excess of government spending it is called a what?
Budget surplus
A decline in AD of $20 billion as a result of a decrease in government spending by $5 billion is a result of the _____ effect
What are the main reasons that deficits have emerged?
War financing
Fiscal policy
The multiplier effect causes the AD curve to shift by an amount ___ than an initial change in government spending.
If the desired initial increase in spending is $5 billion and the MPC is 0.75, the taxes must be ___ by $6.67 billion.
Discretionary fiscal policy action is often taken on the advice of which group?
Council of Economic Advisers
Discretionary fiscal policy involves changes in government spending and taxes at the option of the:
President and Congress
Expansionary fiscal policy is used in response to the economy being in what state?
What was contributed to the large increases in the public debt during the Great Depression?
Federal tax revenues fell
Increased government spending
Incomes decreased
Opponents of increased spending during recession and increased taxes in times of demand-pull inflation, argue that these policies expand or preserve the size of ____.
Virtually any tax will yield more tax revenue as __ rises.
Built-in stability constitutes ______ or “passive” or “automatic” budgetary policy
An increase in government spending on public capital projects such as highways, mass transits, and ports would support long-term economic growth because?
they are complementary to private investment
Mainstream economists generally agree that _____ policy is the best month-to-month stabilization tool for the US economy.
The fiscal policy can help push the economy in a particular direction but cannot fine-tune it to a precise macroeconomic outcome is considered:
the current popular view
The progressive the tax system, the greater the economy’s _______ _______
built-in stability
THe built in stabilizers of an economy depends on the responsiveness of ____ ___ to changes in GDP.
tax revenues
When GDP falls during a recession and tax revenues automatically decline, what increases and cushions the economic contraction?
transfer payments
What is the importance of the direct relationship between tax receipts and GDP when the economy experiences inflationary pressures?
Reductions in spending are desirable when the economy is moving toward inflation
Taxes reduce spending and aggregate demand
The price level is like a(n) _____ in that: increases in AD that expand real output beyond the full-employment level tend to push the price leve upward but declines in AD do not seem to push the price level downward in the same manner.
Why would a tax reduction thought to be temporary not increase present consumption spending and AD as much as expected?
Because people are preparing for the expected higher tax rate in the future.
Evaluating the statue of fiscal policy requires a look at the _____, which measures the deficit or surplus that would occur at the level of potential GDP.
cyclically adjusted budget
The expansionary or contractionary strength of any change in discretionary fiscal policy depends on how large it is relative to the size of:
the economy
One must adjust deficits and surpluses to eliminate automatic changes in tax revenues in order to do what?
Evaluate the status of fiscal policy
Personal income taxes have _____ rates and generate more than proportionate increases in tax revenues as GDP expands.
Tax revenues automatically rise and the budget moves from deficit toward surplus as the economy moes toward a higher
Investment may ____ when businesses expect improved growth prospects from a fiscal stimulus, even if deficit spending does increase interest rates.
Economists recognize that governments may encounter a number of significant problems in doing what?
Applying fiscal policy
Enacting fiscal policy
The enactment of ___ ____may be slowed down because it is conducted in a political arena.
fiscal policy
True or False: Economic considerations always outweighs political considerations in the formulation of fiscal policy
A more meaningful measure of the public debt relates it to an economy’s ____
What are ways that a tax cut’s structure may aim to address long-run aggregate supply?
Encouraging innovation
Strengthening investment
Enhancing work effort
Consumers who believe a tax increase is only temporary may ____ their saving to pay the tax while maintaining their present consumption.

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