Chapter 16: Fiscal Policy

Question 1

The use of government’s budget tools, government spending, and taxes to influence the macroeconomy. Specifically, to engage in counter-cyclical fiscal policy designed to counter the pernicious effects of the business cycle.

Answer 1

Fiscal Policy

Question 2

Problem at the peak is usually ________.

Answer 2

Price Level Inflation

Question 3

Fiscal policy tools are:

Answer 3

(1) Decrease Government spending

(2) Increase Taxes

Question 4

Problem at the trough is ___________.

Answer 4

Unemployment

Question 5

Government increases spending or decreases taxes to stimulate or expand the economy

Answer 5

Expansionary Policy

Question 6

When is expansionary policy used?

Answer 6

Business Cycle Contraction

Question 7

Government decreases spending or increases taxes to attempt to slow economy

Answer 7

Contractionary Policy

Question 8

When is contractionary policy used?

Answer 8

Business Cycle Expansion

Question 9

Expansionary Fiscal Policy : Increase Government Spending

Answer 9

Increasing government spending will increase AD (since government spending is one component of AD), which increases GDP

Question 10

Expansionary Fiscal Policy : Decreasing taxes

Answer 10

Decreasing taxes will raise disposable income and consumption, which will also increase AD and GDP

Question 11

Great Recession Fiscal Policy: Economic Stimulus Act of 2008

Answer 11

Signed by President Bush

Tax rebate for Americans

Totaled $168 billion

Typical family of four receives $1,800

Goal: Increase consumption, stimulate the economy

Question 12

Goal of Economic Stimulus Act of 2008

Answer 12

Goal: Increase consumption, stimulate the economy

Question 13

Goal of American Recovery and Reinvestment Act of 2009

Answer 13

Goal: Increase aggregate demand

Question 14

When government spending increases and taxes decrease, budget deficits increase

Answer 14

Expansionary Fiscal Policy and Budget Deficits

Question 15

Real U.S. Outlays and Revenue, 1990-201

Answer 15

Expansionary fiscal policy inevitably leads to increase in budget deficits and the national debt during economic downturns

Question 16

Contractionary Fiscal Policy

Answer 16

Decrease AD by decreasing government spending or increasing taxes in order to:

(1) Pay off debt that was accrued due to expansionary fiscal policy during bad times
(2) Slow down economy that is “overheated” from too much spending, leading to inflation

Question 17

All else equal, an economy that grows at a consistent rate is preferable to an economy that grows in an erratic fashion

Answer 17

Countercyclical Fiscal Policy

Question 18

Fiscal policy that seeks to counteract business cycle fluctuations

Answer 18

Countercyclical Fiscal Policy

Question 19

Multipliers

Answer 19

The initial effects of fiscal policy can snowball over time

Question 20

Two Central Concepts of Multipliers:

Answer 20

(1) Spending by one person becomes income to others

(2) Increases in income lead to increases in consumption

Question 21

The portion of additional income spent on consumption

Answer 21

Marginal Propensity to Consumer (MPC)

Question 22

MPC =

Answer 22

Change in consumption / Change in income

Question 23

A formula to determine the equation’s effect on spending from an initial change of a given moment

Answer 23

Spending Multiplier

Question 24

There are three reasons why fiscal policy does not always work:

Answer 24

(1) Time lags (3 of them)
(2) Crowding out
(3) Savings adjustment

Question 25

It is difficult to determine when the economy is turning up or down

Answer 25

Recognition lag

Question 26

It takes time to implement fiscal policy

Answer 26

Implementation Lag

Question 27

It takes time for effects of policy to materialize

Answer 27

Impact Lag

Question 28

Government programs that naturally implement countercyclical fiscal policy in response to economic conditions

Answer 28

Automatic Stabilizer

Question 29

When private spending falls in response to increases in government spending.
This reduces the ability of government spending to stimulate aggregate demand.

Answer 29

Crowding Out

Question 30

Implications of Crowding Out

Answer 30

(1) Overall spending may not increase

(2) Government now has higher deficit and debt

Question 31

New Classical Critique

Answer 31

Increases in government spending and decreases in taxes are largely offset by increases in savings

Question 32

When there is an increase in government spending or decrease in taxes…

Answer 32

(1) People recognize that the government has borrowed funds so…
(2) Individuals save to pay for higher future taxes, which reduces consumption
(3) Mitigates the initial purpose of the increase in government spending or decrease in taxes

Question 33

The use of government spending and taxes to affect the production (supply) side of the economy

Answer 33

Supply Side Fiscal Policy

Question 34

Supply Side Initiatives:

Answer 34

(1) R&D tax credits
(2) Education policies (subsidies or tax breaks)
(3) Lower corporate profit tax rates
(4) Lower marginal income tax rates

Question 35

Income Tax Revenue =

Answer 35

Tax Rate x Income

Question 36

In Region I, where tax rates are low, increases in tax rates increase tax revenue.

In Region II, where tax rates are high, increases in tax rates decrease tax revenue.

Answer 36

The Laffer Curve

Question 37

Confirmation of the Laffer Curve’s Existence

Answer 37

During the 1980’s, marginal tax rates were cut
Tax revenues per taxpayer fell, suggesting that lower taxes decrease revenue.
However, taxes paid by the top 1% increased.
This data confirms the existence of the two regions of the Laffer curve.