Deck 8: Fiscal Policy, Deficits, and Debt

Question 1

The Federal government establishes its budget to decide what programs to provide and how to pay for them. How does fiscal policy differ from this ordinary fiscal activity of budgeting

Answer 1

Government expenditure also known as fiscal spending is an important component of real GDP of the economy.
Any change in fiscal expenditure affects the economy significantly.
Fiscal budget is related to deciding upon various activities/programs on which government will spend and how much. Not only this but also from where such fund will be sourced. In simple terms it is deciding in advance for a year about the expenditure of the Federal.
On the other hand, fiscal policies (expansionary or contractionary) are generally related to correct macroeconomic problems like recession and inflation. When economy gets afflicted with recession or any other macro-economic problem, fiscal policies are used as measure to check those such as increasing the spending in times of recession wherein government increases the expenditure over as what w as planned in budget.

Question 2

What are government's fiscal policy options for moving the economy out of a recession Speculate on which of these fiscal options might be favored by (a) a person who wants to preserve the size of government and (b) a person who thinks the public sector is too large. How does the "ratchet effect" affect anti-inflationary fiscal policy

Answer 2

The government fiscal policy options for ending severe demand-pull inflation are decreases in government spending and increase in tax. Both options could achieve the goal of price stability but their impacts on the size of the government are different.
A person who wants to preserve the size of the government might favor increase in tax, so as to rein in severe demand-pull inflation. It would increase the size of the government budget.
A person who thinks that the public sector is too large might favor decrease in government spending, so as to rein in severe demand-pull inflation. It would decrease the size of the government budget.
"Ratchet effect" prevents the price from declining even if anti-inflationary fiscal policies then decline in aggregate demand would result in idle capacity, cyclical unemployment, and a recessionary GDP gap.

Question 3

Explain how built-in (or automatic) stabilizers work. What are the differences between proportional, progressive, and regressive tax systems as they relate to an economy's built-in stability

Answer 3

Automatic or built in stabilizers are those factors which increase the government's budget deficit or reduce budget surplus during a recession time. Similarly these stabilizers reduce budget deficit or increase budget surplus during time of inflation. Such factors don't require any policy efforts and incur automatically and hence are known as in built stabilizers or automatic stabilizers.
U.S tax system is one such kind of stabilizer. In times of inflation when there is requirement of lesser expansion or no further expansion of economy thus reduction in aggregate demand then the tax revenue automatically rises as people are prosperous in wealth. This increase in tax reduces their spending restricting further expansion. ON other hand in recession when income reduces less tax have to be paid which increases the spending and thus expand economy. That is how the stabilizers work.
The tax revenue of Government changes automatically over the course of the business cycle and thus stabilizes the economy automatically. The proportional and progressive tax system reduces tax when economy is in recession and hence reduces the surplus or increases the deficit. On the other hand in times of inflation when there is prosperity and people have good wealth then the tax revenue also increases which automatically reduce household's and business spending restraining economic expansion.
Contrary to above regressive tax system works opposite. It expands the economy during times of inflation and contracts it in recession time.

Question 4

Define the standardized budget, explain its significance, and state why it may differ from the actual budget. Suppose the full-employment, noninflationary level of real output is GDP 3 (not GDP 2 ) in the economy depicted in Figure 8.3. If the economy is operating at GDP 2 instead of GDP 3 , what is the status of its standardized budget The status of its current fiscal policy What change in fiscal policy would you recommend How would you accomplish that in terms of the G and T lines in the figure

Question 5

How would you expect the Economic Stimulus Act of 2008 to affect the actual budget (as a percentage of GDP) and the standardized budget The main feature of the act was a one-time tax rebate to households. How would the actual and standardized budgets be affected if those rebates became permanent tax policy and were distributed annually

Question 6

Briefly state and evaluate the problem of time lags in enacting and applying fiscal policy. How might "politics" complicate fiscal policy How might expectations of a near-term policy reversal weaken fiscal policy based on changes in tax rates What is the crowding out effect, and why might it be relevant to fiscal policy

Question 7

Use Figure 8.4 to explain why the deliberate increase of the standardized budget deficit (resulting from the tax cut) will reduce the size of the actual budget deficit if the fiscal policy succeeds in pushing the economy to its full-employment output of GDP 1. In requesting a tax cut in the early 1960s, President Kennedy said, "It is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise tax revenues in the long run is to cut tax rates now." Relate this quotation to your previous answer in this question.

Question 8

Why did the budget deficits rise sharply in 1991 and 1992 What explains the large budget surpluses of the late 1990s and early 2000s What caused the swing from the budget surpluses to the series of budget deficits beginning in 2002

Question 9

Distinguish between the total U.S. debt and the debt held by the public. Why is the debt as a percentage of GDP more relevant than the total debt Contrast the effects of paying off an internally held debt and paying off an externally held debt.

Question 10

True or false If the statement is false, explain why:
a. An internally held public debt is like a debt of the left hand owed to the right hand.

Question 11

True or false If the statement is false, explain why:
b. The Federal Reserve and Federal government agencies hold more than half of the public debt.

Question 12

True or false If the statement is false, explain why:
c. As a percentage of GDP, the Federal debt held by the public was smaller in 2007 than it was in 1990.

Question 13

Why might economists be quite concerned if the annual interest payments on the debt sharply increased as a percentage of the GDP

Question 14

Trace the cause-and-effect chain through which financing and refinancing of the public debt might affect real interest rates, private investment, the stock of capital, and economic growth. How might investment in public capital and complementarities between public capital and private capital alter the outcome of the cause-effect chain

Question 15

What do economists mean when they refer to Social Security as a pay-as-you-go plan What is the Social Security trust fund What is the nature of the long-run fiscal imbalance in the Social Security retirement system What are the broad options for fixing the long-run problem