Monetary and Fiscal Policy

Question 1

What is Fiscal policy?

Answer 1

A government’s use of taxation and spending to influence the economy.

Question 2

What is monetary policy?

Answer 2

Policy that deals with determining the quantity of money supplied by the central bank.

Question 3

What is the purpose of both fiscal and monetary policy?

Answer 3

To achieve economic growth with price level stability, although governments use fiscal policy for social and political reasons as well.

Question 4

What is a fractional reserve banking system?

Answer 4

• A banking system in which only a fraction of bank deposits are backed by actual cash-on-hand and are available for withdrawal.
• Expands the economy by freeing up capital that can be loaned out to other parties.
• Most countries operate under this type of system.

Question 5

What three factors influence money demand?

Answer 5

1. Transaction demand, for buying goods and services.
2. Precautionary demand, to meet unforseen future needs.
3. Speculative demand, to take advantage of investment opportunities.

Question 6

Who determines the money supply?

Answer 6

Central banks with the goal of managing inflation and other economic objectives.

Question 7

What does the Fisher effect state?

Answer 7

A nominal interest rate is equal to the real interest rate plus the expected inflation rate.

Question 8

What are the six roles of a central bank?

Answer 8

1. Supplying currency,
2. Acting as banker to the govt and to other banks,
3. Regulating/supervising the payments system,
4. Acting as a lender of last resort,
5. Holding the nation’s gold and foreign currency reserves, and
6. Conducting monetary policy.

Question 9

What are the five objectives of central banks?

Answer 9

1. Controlling inflation,(Objective of all)
2. Maintaining currency stability,
3. Full employment,
4. Positive sustainable economic growth, or
5. Moderate interest rates.

Question 10

What three policy tools are available to central banks?

Answer 10

1. Policy rate,
2. Reserve requirements, and
3. Open market operations.

Question 11

What is the policy rate called in the US?

Answer 11

Tthe discount rate

Question 12

What is th policy rate called by the ECB?

Answer 12

Refinancing rate

Question 13

What is the policy rate called in the UK?

Answer 13

The two-week repo rate

Question 14

What are three expansionary measures for policy rates?

Answer 14

1. Decreasing the policy rate,
2. Decreasing reserve requirements, and
3. Making open market purchases of securities are all expansionary.

Question 15

What are three contractionary measures for policy rates?

Answer 15

1. Increasing the policy rate,
2. Increasing reserve requirements, and
3. Making open market sales of securities are all contractionary.

Question 16

Effective central banks exhibit what three qualities?

Answer 16

1. Independence
2. Credibility
3. Transparency

Question 17

What does independence mean for a central bank?

Answer 17

The central bank is free from political interference.

Question 18

What does credibility mean for a central bank?

Answer 18

The central bank follows through on its stated policy intentions.

Question 19

What does transparency mean for a cenral bank?

Answer 19

The central bank makes it clear what economic indicators it uses and reports on the state of those indicators.

Question 20

Monetary policy influences what four things?

Answer 20

1. Market interest rates,
2. Asset prices,
3. Growth expectations, and
4. Exchange rates.

These factors in turn influence domestic and net external demand, which affects economic growth and inflation.

Question 21

What is the real trend rate?

Answer 21

The long-term sustainable real growth rate of an economy.

Question 22

What is the neutral interest rate?

Answer 22

The sum of the real trend rate and the target inflation rate.

Question 23

Is monetary policy contractionary or expansionary when the policy rate is above the neutral rate?

Answer 23

Contractionary

Question 24

Is monetary policy contractionary or expansionary when the policy rate is below the neutral rate?

Answer 24

Expansionary

Question 25

What are three objectives of fiscal policy?

Answer 25

1. Influencing the level of economic activity,
2. Redistributing wealth or income, and
3. Allocating resources among industries.

Question 26

What two types of “tools” are used in fiscal policy?

Answer 26

Spending tools and

Revenue tools.

Question 27

What do fiscal policy spending tools include?

Answer 27

1. Transfer payments,
2. Current spending (goods and services used by government), and
3. Capital spending (investment projects funded by government).

Question 28

What do fiscal policy revenue tools include?

Answer 28

Direct and indirect taxation.

Question 29

What is an advantage of fiscal policy?

Answer 29

That indirect taxes can be used to quickly implement social policies and can also be used to quickly raise revenues at a low cost.

Question 30

What are disadvantages of fiscal policy?

Answer 30

Include time lags for implementing changes in direct taxes and time lags for capital spending changes to have an impact.

Question 31

What are three arguments for being concerned with the size of fiscal deficit?

Answer 31

1. Higher future taxes lead to disincentives to work, negatively affecting long-term economic growth.
2. Fiscal deficits may not be financed by the market when debt levels are high.
3. Crowding-out effect as government borrowing increases interest rates and decreases private sector investment.

Question 32

What are the arguments against being concerned with the size of fiscal deficit?

Answer 32

1. Debt may be financed by domestic citizens.
2. Deficits for capital spending can boost the productive capacity of the economy.
3. Fiscal deficits may prompt needed tax reform.
4. Ricardian equivalence may prevail: private savings rise in anticipation of the need to repay principal on government debt.
5. When the economy is operating below full employment, deficits do not crowd out private investment.

Question 33

What is recognition lag for fiscal policy?

Answer 33

Policymakers may not immediately recognize when fiscal policy changes are needed.

Question 34

What is action lag for fiscal policy?

Answer 34

Governments take time to enact needed fiscal policy changes.

Question 35

What is impact lag for fiscal policy?

Answer 35

Fiscal policy changes take time to affect economic activity.

Question 36

When does a government have a budget surplus?

Answer 36

When tax revenues exceed government spending.

Question 37

When does a government have a budget deficit?

Answer 37

When spending exceeds tax revenue.

Question 38

An increase in a government budget surplus is indicative of?

Answer 38

Contractionary fiscal policy. (and visa versa)