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Econ Chapter 31

The Council of Economic Advisers (CEA) advises the President on
economic matters, and provides recommendations for discretionary fiscal policy action.
The government’s fiscal policy options for ending severe demand-pull inflation include
reducing government spending, increasing taxes, or both.
For a person who wants to preserve the size of government, the fiscal options for ending severe demand-pull inflation would include
an increase in taxes.
For a person who thinks the public sector is too large, the fiscal options for ending severe demand-pull inflation would include
a cut in government spending.
The ratchet effect makes anti-inflationary policy _____.
more difficult
Some politicians have suggested that the United States enact a constitutional amendment requiring that the Federal government balance its budget annually. Such an amendment, if strictly enforced, would force the government to enact a contractionary fiscal policy whenever the economy experienced a severe recession.
This is because when the economy enters a recession,
net tax revenue falls and transfer payments rise. Balancing the budget would require lowering transfer payments and raising taxes.
Built-in, or automatic, stabilizers work by changing ______ so that GDP changes are reduced.
taxes and government payouts
What type of tax system would have the most built-in stability?
A progressive tax because it increases at an increasing rate as incomes rise, thus having more of a dampening effect on rising (or falling) incomes.
The standardized budget measures what the Federal deficit or surplus would be if the economy reached the ______ level of GDP
If the standardized budget is balanced, the
government is not engaging in either expansionary or contractionary policy.
The problem of time lags in enacting and applying fiscal policy is that
in the time it takes to identify the situation, enact a policy, and allow it to work, economic circumstances may have changed.
A political business cycle is the concept that
politicians are more interested in reelection than in stabilizing the economy.
Expectations of a near-term policy reversal weaken fiscal policy because
consumers may hesitate to increase their spending because they believe that tax rates will rise again.
The crowding-out effect is the
reduction in investment spending caused by the increase in interest rates, arising from an increase in government spending.
Consider the following statement: “Although fiscal policy clearly is useful in combating the extremes of severe recession and demand-pull inflation, it is impossible to use fiscal policy to fine-tune the economy to the full-employment, noninflationary level of real GDP and keep the economy there indefinitely.”

This statement recognizes that

the impact of fiscal policy will affect the economy differently depending on the timing of the policy and the severity of the situation.
What are the two ways to measure the public debt?
Its absolute dollar size and as a percentage of GDP
The distinction between the absolute and relative sizes of the public debt is important because
the absolute size doesn’t tell you about an economy’s capacity to repay the debt.
Refinancing the public debt means
selling new bonds to retire maturing bonds.
An internally held debt is one in which the
bondholders live in the nation having the debt.
Paying off an internally held debt would
not burden the economy as a whole.
Paying off an externally held debt
may lower the dollar exchange rate.
a. The total public debt is more relevant to an economy than the public debt as a percentage of GDP.
b. An internally held public debt is like a debt of the left hand owed to the right hand.
c. The Federal Reserve and Federal government agencies hold more than three-fourths of the public debt
d. The portion of the U.S. debt held by the public (and not by government entities) was larger as a percentage of GDP in 2009 than it was in 2000.
e. As a percentage of GDP, the total U.S. public debt is the highest such debt among the world’s advanced industrial nations.
If the annual interest payments on the debt sharply increased as a percentage of the GDP,
the government would have to use tax revenues or go deeper into debt.
Refinancing of the public debt might drive up real interest rates because
government borrowing to finance the debt increases demand for funds and competes with private borrowing.
Refinancing of the public debt might cause
higher interest rates that can lower investment and economic growth.
If the public investment financed through borrowing complements private investment,
private borrowers may be willing to pay higher interest rates associated with financing the public debt.
Social Security and Medicare are “pay-as-you-go” plans. This means that
most of the current revenues from the Social Security tax are paid to current Social Security retirees.
Social Security and Medicare trust funds are
assets held by these programs to help pay for future projected tax revenue shortfalls.
Social Security and Medicare trust funds are projected to be depleted by
2037 and 2017 respectively.
The key long-run problem of both Social Security and Medicare is the
aging, and the age distribution, of the U.S. population.
Which of the following would help a government reduce an inflationary output gap?
During the recession of 2007?2009, the U.S. Federal government’s tax collections fell from about $2.6 trillion down to about $2.1 trillion while GDP declined by about 4 percent. Does the U.S. tax system appear to have built-in stabilizers?
Suppose that last year, the economy was in a recession, government spending was $595 billion and government revenue was $505 billion. Economists estimate that if the economy had been at its full-employment level of GDP last year, government spending would have been $555 billion and government revenue would have been $550 billion. Which of the following statements about this government’s fiscal situation are true?
a. To fight a recession, Congress has passed a bill to increase infrastructure spending—but the legally required environmental-impact statement for each new project will take at least two years to complete before any building can begin.
Operational lag
b. Distracted by a war that is going badly, inflation reaches 8 percent before politicians take notice.
Recognition lag
c. A sudden recession is recognized by politicians, but it takes many months of political deal making before a stimulus bill is finally approved.
administrative lag
d. To fight a recession, the president issues an executive order requiring Federal agencies to get rid of petty regulations that burden private businesses—but the Federal agencies begin by spending a year developing a set of regulations on how to remove petty regulations.
operational lag
In January, the interest rate is 5 percent and firms borrow $50 billion per month for investment projects. In February, the Federal government doubles its monthly borrowing from $25 billion to $50 billion. That drives the interest rate up to 7 percent. As a result, firms cut back their borrowing to only $30 billion per month. Which of the following is true?
There is a crowding-out effect of $20 billion.
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