Chapter 18 Flashcards
What is fiscal policy?
The Federal govt policy on taxes, spending, and borrowing
Designed to influence business fluctuations
What are the components of aggregate demand?
C, I, G, NX
What is crowding out?
the decrease in provate consumption and investment that occurs when government borrows more; also the decrease in private spending when government increases spending
What are 4 major limits to fiscal policy?
- Crowding out
- A drop in the bucket
- A matter of timing
- Real shocks
When is the case for fiscal policy the strongest?
When the economy is in a recession caused by low aggregate demand
Government spending shifts the aggregate demand curve to the…
right
What is the multiplier effect?
The additional increase in AD caused when expansionary fiscal policy
increases income and thus consumer spending.
A tax cut or tax rebate puts more spending in the hands of who?
The private sector
An increase in government spending puts more spending in the hands of who?
The government
Describe the crowding out limit to fiscal policy
Government spending leads to less private spending, reducing the increase in AD.
Describe the drop in the bucket limit to fiscal policy
The economy is so large that government can rarely increase spending enough to have a large impact.
Describe the matter of timing limit to fiscal polciy
It can be difficult to time fiscal policy so that AD shifts at the right time.
What two ways is increased spending paid for?
- Raising taxes
2. Borrow more(sell bonds)
What are 2 types of expansionary fiscal policy?
- Increased spending
2. Tax Cuts
How are tax cuts paid for?
Borrowing more(selling bonds)
When the new government spending is financed by increased taxes, individuals have ______ money to spend.
less
When people are otherwise afraid to spend their money, fiscal policy will be most..
effective
If people buy more government bonds but fewer private bonds, then growth in investment..
declines
To sell more bonds, the government must offer a higher …
interest rate
Selling more bonds reduces..
private investment and private consumption
To increase the incentive to invest or work, the govt must cut marginal tax..
rates
What is ricardian equivalence?
Occurs when people see that lower taxes today means higher taxes in the future, so instead of spending their tax cut, they save it to pay future taxes. When Ricardian equivalence holds, a tax cut doesn’t increase aggregate demand even
in the short run.
What are the potential lags?
- Recognition lag
- Legislative lag
- Implementation lag
- Effectiveness lag
- Evaluation and adjustment lag
What are automatic stabilizers?
Changes in fiscal policy that stimulate AD in a recession without the need for explicit action by policymakers.
When is fiscal policy less effective?
If a contraction in the economy is due to a real shock
In what 3 situations is fiscal policy most likely to matter?
- When the economy needs a short-run boost, even at the expense of the long run.
- When the problem is a deficiency in aggregate
demand rather than a real shock.
3.When many resources are unemployed.
What is recognition lag?
The problem must be recognized
What is legislative lag?
Congress must propose and pass a plan
What is implementation lag?
Beauracies must implement a plan
What is effectiveness lag?
The plan takes time to work
What is evaluation and adjustment lag?
Did the plan work?Have conditions changed?
