22-23: Fiscal Policy

Question 1

government budget consists of

Answer 1

outlays (government spending = G + interest payments + transfer payments)

receipts (taxes)

Question 2

government deficit

Answer 2

outlays - receipts = G + transfer payments + interest payments - taxes

Question 3

how are government outlays financed?

Answer 3

tax revenues

borrowing from the public (bonds)

changes in the money supply

Question 4

government budget constraint

Answer 4

deficit = change in debt held by the public + change in monetary base

• monetary base as the amount of currency held by people and in reserve

Question 5

when is government debt not a burden?

Answer 5

spending for investment increases productive assets/human capital which generates rate-of-return in excess of borrowing costs

Question 6

when is government debt a burden?

Answer 6

reduces national saving and crowds out private investment

spending for government consumption

spending for investment that have a rate-of-return below borrowing cost

redistribution of income/wealth effects from taxpayers to bondholders

debt is held by foreigners

debt intolerance (debt too large and fear of debt repudiation)

negative incentive effects to work/invest when taxes are raised

Question 7

expansionary fiscal policies in the short-run

Answer 7

tax smoothing
- keeping tax rates stable even when revenue and government spending fluctuate with economic activity

increase in government spending

reduction in tax rates

Question 8

supply-side argument

Answer 8

reduction in taxes increases autonomous Y and potential output

no change in output gap (may go negative)

leads to higher income with no change or lower inflation

Question 9

ricardian equivalence

Answer 9

implies that tax cuts have no effect on spending and national saving

assumption that households recognise a tax cut creates a larger budget deficit to be paid for with higher taxes in the future

expected future disposable income is lower, so consumers do not change spending