Deck 32: The Fiscal Policy Dilemma

Question 1

The theoretical proposition that government deficits do not affect the level of output because individuals realize that they have to pay the deficits in the future and therefore increase their savings is called:

A)purchasing power parity.
B)functional finance.
C)the Ricardian equivalence theorem.
D)sound finance.

Answer 1

the Ricardian equivalence theorem.

Question 2

According to the Ricardian equivalence theorem, people increase savings today when the government increases deficits because they recognize that:

A)government deficits imply higher future taxes.
B)government deficits imply lower future taxes.
C)consumption reduces future taxes.
D)consumption increases future taxes.

Answer 2

government deficits imply higher future taxes.

Question 3

According to the Ricardian equivalence theorem, government deficits do not affect output because people:

A)save more when government deficits decrease.
B)save more when government deficits increase.
C)consume more when government deficits increase.
D)do not change consumption nor savings.

Answer 3

save more when government deficits increase.

Question 4

Economists who believe in sound finance would say that in a recession, the government should:

A)run a budget deficit because the Ricardian equivalence theorem is true both in theory and in practice.
B)run a budget deficit despite the truth of the Ricardian equivalence theorem.
C)maintain a balanced budget because the Ricardian equivalence theorem is true in practice.
D)maintain a balanced budget for political and moral reasons.

Question 5

The concept of fiscal policy refers to the:

A)running of a deficit or surplus to affect the level of output in the economy.
B)changing of interest rates to affect the level of output in the economy.
C)management of exchange rates to affect the trade deficit in the economy.
D)setting of wage policies by institutions to affect spending in the economy.

Question 6

The view that the government budget should always be balanced except in wartime refers to:

A)public finance.
B)fiscal policy.
C)the Ricardian equivalence.
D)sound finance.

Question 7

The government's running of a deficit or a surplus with the objective of affecting the level of output in the economy is called:

A)public finance.
B)fiscal policy.
C)the Ricardian equivalence.
D)sound finance.

Question 8

The application of Keynesian economics to public finance and fiscal policy by Abba Lerner, and its incorporation into Paul Samuelson's economic principles textbook, was known as procyclical finance.

Question 9

Which of the following best describes most economists' approach to economic stabilization until the 1930s?

A)Maintain a balanced budget at all times, under the principle of sound finance.
B)Use a sound finance approach during normal economic times, and a functional finance approach during a recession or a boom.
C)Run larger deficits during recessions and smaller deficits during economic booms, counting on economic growth to be high enough to keep the debt-to-GDP ratio low.
D)Economists were wholly concerned with microeconomics and had ignored problems of government deficits, debt, recessions, and economic growth.

Question 10

During the early 20th century, economists who held that the Ricardian equivalence theorem was theoretically true could support either sound or functional finance.

Question 11

According to the Ricardian equivalence theorem, people increase savings when the government increases deficits because they recognize the link between government deficits and higher future taxes.

Question 12

The elimination of automatic stabilizers would decrease the need for other fiscal policies.

Question 13

According to the Ricardian equivalence theorem, government deficits do not affect the level of output because people:

A)do not understand the relationship between deficits and aggregate demand.
B)know that current deficits must be paid in the future and therefore reduce savings today.
C)recognize that current deficits must be paid by future generations and therefore spend more today.
D)recognize that current deficits must be paid in the future and therefore increase savings today to pay higher future taxes.

Question 14

Financing expansionary fiscal policy by increasing the deficit does not generally affect interest rates.

Question 15

The Ricardian equivalence theorem is correct if two assumptions are true.These assumptions are that people have:

A)access to savings instruments and recognize the link between deficits and future taxes.
B)no access to savings instruments and recognize the link between deficits and future taxes.
C)access to savings instruments but cannot recognize the link between deficits and future taxes.
D)no access to savings instruments and cannot recognize the link between deficits and taxes.

Question 16

Automatic stabilizers are government programs or policies that will counteract the business cycle without any new government action.

Question 17

Crowding out is the offsetting effect on private expenditures caused by the government's sale of bonds to finance expansionary fiscal policy.

Question 18

The 2008-2009 deficit stimulus spending by the federal government is an example of expansionary sound finance.

Question 19

If the government knew the level of potential income and had sufficient information about the economy (i.e., the mpe, and such), it could fine-tune the economy.

Question 20

Sound finance holds that government spending should be directed toward sound investment.

Question 21

Although macroeconomics textbooks have taught the logic of fiscal policy for over half a century, actual use of discretionary fiscal policy has been rare.When President George W.Bush persuaded Congress to enact a large tax cut early in his presidency, it was the first time in several decades that the fiscal policy rationale was taken seriously.Why has fiscal policy been used so infrequently?

A)It has inherent conflicts with monetary policy.
B)Concern about exchange-rate stabilization has limited its effectiveness.
C)The political processes of democracy make timely fiscal policy difficult.
D)Fiscal policy has proven to be too strong a medicine for the small economic fluctuations we have had.

Question 22

In the early 2000s, car sales in China slowed because the government had been restricting credit growth.This action is consistent with the effects of:

A)contractionary fiscal or monetary policy.
B)contractionary fiscal policy but not contractionary monetary policy.
C)contractionary monetary policy but not contractionary fiscal policy.
D)expansionary fiscal policy.

Question 23

Crowding out would most likely occur when:

A)workers lose jobs as a result of anti-inflationary fiscal policies.
B)the federal government engages in bond sales to finance its budget deficit.
C)Congress enacts budget cuts to balance the budget.
D)tax receipts rise more slowly than anticipated, resulting in the need to cut government spending.

Question 24

When the government runs a deficit, the interest rate tends to:

A)rise.
B)fall.
C)remain unchanged.
D)rise or fall, depending on how the deficit is financed.

Question 25

When the economy is experiencing inflation, an economist who follows a functional finance principle is most likely to suggest that the government should:

A)do nothing.
B)run a deficit.
C)run a surplus.
D)run a balanced budget.

Question 26

Which of the following is most representative of the functional finance view of the macroeconomy?

A)The economy is self-regulating and the best thing the government can do to enhance stability is to stay out of the way.
B)Budgets should be balanced.Doing otherwise is morally wrong.
C)The government should decide on tax and spending plans based on their effects on the economy.
D)Crowding out almost completely cancels out any deficit spending, so fiscal policy is likely to be ineffective.

Question 27

Refer to the graph shown.Expansionary fiscal policy is most likely to shift the aggregate demand curve from:

A)AD₀ to AD₂ if crowding out does not occur and from AD₀ to AD₁ if crowding out does occur.
B)AD₀ to AD₂ if crowding out does not occur and from AD₀ to AD₃ if crowding out does occur.
C)AD₂ to AD₀ if crowding out does not occur and from AD₁ to AD₂ if crowding out does occur.
D)AD₂ to AD₀ if crowding out does not occur and from AD₁ to AD₃ if crowding out does occur.

Question 28

An economist who follows a functional finance principle believes that the government should:

A)do nothing in response to a recession.
B)do nothing in response to a recession due to the Ricardian equivalence theorem.
C)run either a deficit or surplus depending on the state of the economy.
D)run a balanced budget.

Question 29

Refer to the graph shown.Suppose the government borrows $50 million to finance an increase in its spending and that as a result, the level of investment is reduced by $50 million.In this case, the aggregate demand curve will:

A)shift from AD₀ to AD₂ but then back to AD1.
B)shift from AD₀ to AD₂ but then out to AD3.
C)shift from AD₀ to AD2.
D)not shift.

Question 30

Fine tuning the economy with fiscal policy is:

A)relatively simple because the government has access to the best information available.
B)difficult because the government lacks important information about the economy.
C)relatively simple because the political process usually works smoothly and without significant lags.
D)difficult because economists have not developed any theoretical models of the macroeconomy.

Question 31

Functional finance:

A)is based on empirical evidence that fiscal policy can be effective in smoothing business cycles.
B)is based on the political realities of voters wanting their government to respond to recessions.
C)is a theoretical proposition, not a moral proposition.
D)is a proposition supported by public choice economists.

Question 32

Reducing the budget deficit by cutting government spending could conceivably:

A)increase income if interest rates fall enough and private investment is more productive than government spending.
B)increase income if interest rates rise enough and government spending is more productive than private investment.
C)decrease income if interest rates fall too much and private investment is more productive than government investment.
D)decrease income if interest rates rise enough and private investment is more productive than government investment.

Question 33

Refer to the graph shown.Expansionary fiscal policy shifts the aggregate demand curve from:

A)AD₀ to AD₂ but then back to AD₁ if crowding out occurs.
B)AD₀ to AD₂ but then out to AD₃ if crowding out occurs.
C)AD₀ to AD₂ whether or not crowding out occurs.
D)AD₂ to AD₁ and then from AD₁ to AD₀ if crowding out occurs.

Question 34

Even as the U.S.government ran large budget deficits in the early 2000s, the interest rate did not rise substantially.Which of the following is among the reasons that crowding out did not raise interest rates at that time?

A)Americans increased their willingness to save at the same time that the budget deficits appeared.
B)The government spent the borrowed money in such a way that productivity and therefore the availability of savings dramatically increased.
C)The Federal Reserve decreased the money supply.
D)Foreigners were willing to finance the U.S.deficit with their abundant supply of savings.

Question 35

According to most economists, fiscal policy is:

A)not an effective tool for fine tuning the economy.
B)least useful in a serious economic crisis.
C)always ineffective because of crowding out.
D)effective only when potential output is perfectly known.

Question 36

If a government finances an increase in its expenditures by selling bonds to the public, then the aggregate demand curve will:

A)not shift.
B)shift out but not as much as it would if crowding out didn't occur.
C)shift out by the same amount regardless of whether crowding out occurs.
D)shift out more if crowding out occurs.

Question 37

Using fiscal policy to stabilize the economy is difficult because:

A)potential income is known.
B)the effects of policy changes is known with certainty.
C)there are time lags involved in the use of fiscal policy.
D)the size of the government debt doesn't matter.

Question 38

Fiscal policy would be more effective if:

A)potential income was unknown.
B)the government could change taxes and expenditures rapidly.
C)the size of the government debt didn't matter.
D)crowding out occurred more often.

Question 39

Between 1999 and 2009, the U.S.federal budget deficit moved from a record surplus to a record deficit.Other things being equal, the most likely effect of this shift would be:

A)higher interest rates and increased investment.
B)higher interest rates and decreased investment.
C)lower interest rates and increased investment.
D)lower interest rates and decreased investment.

Question 40

A key difference between functional finance and sound finance is that in the functional finance approach the government has the potential for:

A)a more active role in spending and taxing decisions.
B)a less active role in spending and taxing decisions.
C)no role since functional finance holds that on moral principle the budget should be balanced.
D)more active role in spending and taxing but only during depressions.

Question 41

If the government knew the precise values of the multiplier and potential income, fine-tuning the economy would:

A)be possible.
B)be much easier but mistakes would still occur occasionally.
C)still be very difficult.
D)be more difficult.

Question 42

In practice, economists:

A)agree about what the level of potential output is but disagree about what policies are appropriate.
B)disagree about what the level of potential output is but agree about what policies are appropriate.
C)agree about what the level of potential output is and about what policies are appropriate.
D)disagree about what the level of potential output is and about what policies are appropriate.

Question 43

A decrease in the budget deficit will have a:

A)more negative effect on income when crowding out is strong.
B)more positive effect on income when crowding out is weak.
C)less negative effect on income when crowding out is strong.
D)less positive effect on income when crowding out is weak.

Question 44

Crowding out is associated with:

A)a reduction in business investment resulting from an increase in government borrowing and higher interest rates.
B)an increase in business investment resulting from an increase in government borrowing and higher interest rates.
C)an increase in private savings caused by higher future tax liabilities when government increases borrowing.
D)a decrease in government spending caused by a shortage of available credit.

Question 45

Expansionary fiscal policy that raises the budget deficit may:

A)reduce business investment by increasing interest rates.
B)reduce business investment by reducing interest rates.
C)increase business investment by increasing interest rates.
D)increase business investment by reducing interest rates.

Question 46

Most of the government budget is mandatory spending through programs like Medicare and Social Security, and much of the rest is politically difficult to alter.Because of this:

A)fiscal policy is always undertaken only when there is a national crisis that motivates voters to seek change.
B)fiscal policy that involves raising taxes is more likely to be implemented than fiscal policy that involves borrowing money.
C)the amount of spending is unlikely to be implemented as economists suggest.
D)most spending is geared to perform as an automatic stabilizer, so that Congress is in fact largely irrelevant when it comes to providing a fiscal response to a recession.

Question 47

Crowding out:

A)increases the multiplier effect, so that an increase in government spending raises income by more.
B)increases the multiplier effect, so that an increase in government spending raises income by less.
C)decreases the multiplier effect, so that an increase in government spending raises income by more.
D)decreases the multiplier effect, so that an increase in government spending raises income by less.

Question 48

Which of the following issues will economists likely agree about?

A)The long-run achievable target rate of unemployment
B)Estimates of potential income
C)The relationship between the level of economic activity and inflation
D)Outside of some range, too much spending causes inflation and too little causes a recession

Question 49

When interest rates go up, it is:

A)more expensive for businesses to borrow, so investment falls.
B)more expensive for businesses to borrow, so investment increases.
C)cheaper for businesses to borrow, so investment falls.
D)cheaper for businesses to borrow, so investment increases.

Question 50

Activist fiscal policies:

A)generally produce balanced budgets.
B)usually produce budget surpluses.
C)usually produce budget deficits.
D)do not have any systematic effect on budget surpluses or deficits.

Question 51

Suppose the government increases spending by $30 billion and raises taxes by $20 billion at the same time.Then:

A)interest rates will most likely stay the same.
B)interest rates will most likely increase.
C)business investment is not likely to change.
D)business investment is likely to increase due to crowding out.

Question 52

Fiscal policy is typically:

A)extremely flexible because most government spending is discretionary.
B)extremely flexible provided policy lags are short.
C)flexible despite the presence of implementation problems.
D)difficult to implement quickly.

Question 53

When the government runs a deficit it must:

A)buy bonds to finance the deficit.
B)sell bonds to finance the deficit.
C)decrease the money supply to finance the deficit.
D)raise taxes immediately.

Question 54

If interest rates adjust to equate savings and investment, then an expansionary fiscal policy is:

A)more likely to increase interest rates and less likely to crowd out investment.
B)more likely to increase interest rates and more likely to crowd out investment.
C)less likely to increase interest rates and less likely to crowd out investment.
D)less likely to increase interest rates and more likely to crowd out investment.

Question 55

If private investment is relatively sensitive to interest rates, then a fiscal expansion financed by government bond sales will:

A)have no effect on output.
B)raise output by a relatively small amount.
C)raise output by a relatively large amount.
D)have an ambiguous effect on output.

Question 56

Crowding out will be less likely to occur if:

A)interest rates rise when the budget deficit increases.
B)interest rates fall when the budget deficit decreases.
C)business investment does not depend on interest rates.
D)business investment depends on interest rates.

Question 57

Suppose most economists agree that the target rate of unemployment is between 4 and 7 percent.If the actual unemployment rate is 11 percent, then most economists would agree that:

A)both expansionary and contractionary policies are appropriate.
B)expansionary monetary and fiscal policies are appropriate.
C)contractionary monetary and fiscal policies are appropriate.
D)neither expansionary nor contractionary policies are appropriate.

Question 58

Contractionary fiscal policy that reduces the budget deficit may:

A)reduce business investment by increasing interest rates.
B)reduce business investment by reducing interest rates.
C)increase business investment by increasing interest rates.
D)increase business investment by reducing interest rates.

Question 59

If a fiscal expansion financed by government bond sales does not affect interest rates, then:

A)no crowding out will occur.
B)crowding out will be relatively small.
C)crowding out will be relatively large.
D)crowding out will be so great that output will decline.

Question 60

The crowding out effect:

A)increases the multiplier effect, so that an increase in taxes reduces income by more.
B)increases the multiplier effect, so that an increase in taxes reduces income by less.
C)decreases the multiplier effect, so that an increase in taxes reduces income by more.
D)decreases the multiplier effect, so that an increase in taxes reduces income by less.

Question 61

Which of the following policies would reduce the procyclical nature of fiscal policy at the state level?

A)The establishment of "rainy day funds"
B)The introduction of price controls
C)The institution of balanced budget requirements
D)The elimination of automatic stabilizers

Question 62

If the economy falls into a recession, automatic stabilizers will cause:

A)tax receipts to fall and government spending to rise.
B)tax receipts to rise and government spending to fall.
C)both tax receipts and government spending to rise.
D)both tax receipts and government spending to fall.

Question 63

The introduction of "rainy-day funds" by states would:

A)decrease the procyclical nature of current state budgeting procedures.
B)increase the procyclical nature of current state budgeting procedures.
C)decrease the counter-cyclical nature of current state budgeting procedures.
D)increase the counter-cyclical nature of current state budgeting procedures.

Question 64

Which of the following would not be considered an automatic stabilizer?

A)Welfare payments
B)Unemployment compensation
C)Income tax
D)Defense spending

Question 65

The crowding out effect would be lower if:

A)consumption was sensitive to changes in prices.
B)the government always ran budget deficits.
C)the interest rate was greatly affected by shifts in the demand of loanable funds.
D)investment was not sensitive to changes in the interest rates.

Question 66

In terms of fiscal policy, which of the following is an example of a fiscal automatic stabilizer?

A)The reduction in the money supply that occurs as banks become less willing to make loans during a recession
B)The reduction in wages that occurs as the economy goes into a recession
C)The increase in government spending that occurs as the result of new spending bills passed by Congress
D)The rise in tax revenue that occurs as a result of growth in real GDP

Question 67

Generally speaking, the government implements fiscal policy in a:

A)fast and accurate manner.
B)slow and inaccurate manner.
C)fast but inaccurate manner.
D)slow but accurate manner.

Question 68

Because automatic stabilizers increase government spending and decrease tax revenue during a recession and have the opposite effect during a recovery, they tend to create budget:

A)deficits throughout the business cycle.
B)surpluses throughout the business cycle.
C)deficits during the recovery phase of the business cycle and budget surpluses during the recession phase.
D)deficits during the recession phase of the business cycle and budget surpluses during the recovery phase.

Question 69

As the economy contracts, tax revenues:

A)fall and transfer payments rise, causing the economy to contract by less than it would in the absence of automatic stabilizers.
B)rise and transfer payments rise, causing the economy to contract by more than it would in the absence of automatic stabilizers.
C)fall and transfer payments fall, causing the economy to contract by more than it would in the absence of automatic stabilizers.
D)rise and transfer payments fall, causing the economy to contract by less than it would in the absence of automatic stabilizers.

Question 70

Which of the following is an automatic stabilizer?

A)Military expenditures
B)Social Security benefits
C)Unemployment compensation
D)Property taxes

Question 71

As the economy expands, tax revenues:

A)fall and transfer payments rise, causing the economy to expand by less than it would in the absence of automatic stabilizers.
B)rise and transfer payments rise, causing the economy to expand by more than it would in the absence of automatic stabilizers.
C)fall and transfer payments fall, causing the economy to expand by more than it would in the absence of automatic stabilizers.
D)rise and transfer payments fall, causing the economy to expand by less than it would in the absence of automatic stabilizers.

Question 72

During an economic contraction, automatic stabilizers:

A)reduce both budget surpluses and deficits.
B)reduce a budget surplus or increase a deficit.
C)reduce a budget deficit or increase a surplus.
D)increase both budget surpluses and deficits.

Question 73

During an economic expansion, automatic stabilizers:

A)reduce both budget surpluses and deficits.
B)reduce a budget surplus or increase a deficit.
C)reduce a budget deficit or increase a surplus.
D)increase both budget surpluses and deficits.

Question 74

Automatic stabilizers cause:

A)deeper recessions and more rapid expansions.
B)deeper recessions and slower expansions.
C)shallower recessions and slower expansions.
D)shallower recessions and more rapid expansions.

Question 75

If output is falling, a procyclical fiscal policy will result in:

A)higher taxes and/or increased government spending.
B)higher taxes and/or decreased government spending.
C)lower taxes and/or increased government spending.
D)lower taxes and/or decreased government spending.

Question 76

In 2009, output was beneath potential.At the same time, the budget deficit hit a record high of over $1 trillion.If President Obama were to have pursued budget cuts, given the state of the economy, these spending cuts would have:

A)been procyclical.
B)been countercyclical.
C)increased interest rates.
D)crowded out investment.

Question 77

Because reducing both unemployment and inflation simultaneously are conflicting goals:

A)there is a policy that will allow policymakers to achieve either objective.
B)aggregate demand policy will allow policymakers to achieve one of these objectives, but not both.
C)aggregate demand policy will allow policymakers to achieve both objectives, but only if it is expansionary.
D)aggregate demand policy will allow policymakers to achieve both objectives, but only if it is contractionary.

Question 78

Because automatic stabilizers lower transfer payments and raise tax receipts as an economy recovers from a recession, they:

A)slow down the pace of an economic recovery.
B)increase the pace of an economic recovery.
C)do not affect the pace of an economic recovery.
D)accelerate the recovery from a recession until inflation starts to develop, at which point they slow the recovery.

Question 79

Procyclical fiscal policies:

A)reduce cyclical fluctuations in the economy, but not as effectively as countercyclical fiscal policies.
B)reduce cyclical fluctuations in the economy more effectively than countercyclical fiscal policies.
C)reduce cyclical fluctuations in the economy about as effectively as countercyclical fiscal policies.
D)increase cyclical fluctuations in the economy.

Question 80

An example of a procyclical fiscal policy is:

A)an income tax.
B)unemployment compensation.
C)a balanced budget policy.
D)welfare payments.