Deck 13: Fiscal Policy in the Short Run

Question 1

Other things equal,an increase in transfer payments will ________ consumption expenditures,which leads to ________ in output and employment.

A) increase; an increase
B) increase; a decrease
C) decrease; an increase
D) decrease; a decrease

Answer 1

A

Question 2

The automatic budget deficits and budget surpluses that occur in the federal budget over the business cycle

A) destabilize the economy.
B) stabilize the economy.
C) decrease potential GDP.
D) increase potential GDP.

Answer 2

B

Question 3

Other things equal,which of the following will lead to an increase in output and employment?

A) The federal government decides to eliminate the Department of Education.
B) The federal government implements a national value-added tax (VAT).
C) The federal government passes a tax incentive for firms that employ returning war veterans.
D) The federal government reduces the duration and amount of unemployment benefits.

Answer 3

C

Question 4

Expansionary fiscal policy would involve ________,whereas contractionary fiscal policy would involve ________.

A) increasing the money supply; increasing personal income taxes
B) increasing corporate income taxes; raising interest rates
C) increasing transfer payments; increasing corporate income taxes
D) increasing government purchases; increasing transfer payments

Question 5

A key reason that most people did not anticipate the severity of the Great Recession is that

A) they thought the Bank of Canada would reduce the target for the federal funds rate to a lower level.
B) they did not believe that the federal government would actually bail out large financial institutions.
C) they failed to see the financial crisis coming.
D) they were more worried about rising inflation than about falling real GDP.

Question 6

The deliberate change in taxes,transfer payments,or government expenditures to achieve macroeconomic policy objectives is known as

A) expansionary fiscal policy.
B) contractionary fiscal policy.
C) discretionary fiscal policy.
D) automatic stabilizers.

Question 7

Which of the following would be classified as fiscal policy?

A) Provinces increase taxes to fund education.
B) The Bank of Canada lowers interest rates to stimulate the economy.
C) The federal government passes tax cuts to encourage households to install solar panels.
D) The federal government lowers tax rates to stimulate the economy.

Question 8

Historically,the largest Canadian federal budget deficits as a percentage of GDP in the last 50 years occurred between

A) 1965-1968.
B) 1980-1985.
C) 1975-1997.
D) 1997-2007.

Question 9

What is the goal of fiscal policy,and what tools have policymakers traditionally used to conduct fiscal policy?

Question 10

For each of the following situations,choose a fiscal policy and explain how it could be used to correct the economic problem.
a. Real GDP is below potential GDP following a financial market crisis.
b. A positive demand shock increases aggregate expenditure beyond the full employment level and leads to fears of rising inflation.
c. The economy is in a recession due to rising defaults on mortgages following the bursting of a housing bubble.

Question 11

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

A) rising corporate income tax revenues due to an expanding economy
B) increasing welfare payments due to more people becoming unemployed during a recession
C) legislation increasing funding for job retraining passed during a recession
D) decreasing employment insurance payments due to increased employment during an expansion

Question 12

The increase in the amount that the government collects in taxes when the economy expands and the decrease in the amount that the government collects in taxes when the economy goes into a recession are examples of

A) discretionary monetary policy.
B) the discretionary multiplier effect.
C) discretionary fiscal policy.
D) automatic stabilizers.

Question 13

Explain the differences between expansionary and contractionary fiscal policies,and list the typical actions that are used for expansionary and contractionary fiscal policies.

Question 14

The goal of fiscal policy is to ________,and typically focuses on ________.

A) balance the federal budget; tax rates and tax revenues
B) stabilize the supply of money in the economy; price stability
C) reduce the severity of economic fluctuations; employment and production
D) eliminate balance of payments deficits or surpluses; exchange rate stability

Question 15

Fiscal policy refers to changes in

A) the money supply and interest rates that are intended to achieve macroeconomic policy objectives.
B) federal taxes, purchases, and transfer payments that are intended to achieve macroeconomic policy objectives.
C) federal taxes, purchases, and transfer payments that are intended to achieve environmental and national defence policy objectives.
D) provincial and local taxes and purchases that are intended to achieve provincial and local policy objectives.

Question 16

Other things equal,an increase in corporate income taxes will ________ the after-tax profitability of investment projects,which leads to ________ in output and employment.

A) increase; an increase
B) increase; a decrease
C) decrease; an increase
D) decrease; a decrease

Question 17

Other things equal,a decrease in the personal income tax rate will ________ disposable income,which leads to ________ in output and employment.

A) increase; an increase
B) increase; a decrease
C) decrease; an increase
D) decrease; a decrease

Question 18

Holding all else constant,a decrease in consumption taxes,such as sales taxes or a VAT,will ________ aggregate expenditure and ________ employment.

A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease

Question 19

Changes in taxes,transfer payments,or government expenditures that naturally occur with the business cycle are known as

A) expansionary fiscal policy.
B) contractionary fiscal policy.
C) discretionary fiscal policy.
D) automatic stabilizers.

Question 20

Holding all else constant,an increase in consumption taxes,such as sales taxes or a VAT,will ________ the price of consumption goods and ________ output.

A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease

Question 21

An increasing federal budget deficit will ________ the federal government debt as this will ________ the total value of Canadian government bonds outstanding.

A) increase; increase
B) increase; decrease
C) not impact; not change
D) not impact; be offset by

Question 22

Explain the differences between a federal budget deficit,a federal budget surplus,and the federal government debt.

Question 23

A recession tends to cause the federal budget deficit to ________ because tax revenues ________ and government spending on transfer payments ________.

A) increase; rise; falls
B) decrease; rise; falls
C) increase; fall; rises
D) decrease; fall; rises

Question 24

The federal government debt as a percentage of GDP fell during

A) 2008-2010.
B) 1980-1995.
C) 1996-2006.
D) World War II.

Question 25

What is a cyclically adjusted budget deficit or surplus,and how is it used to determine whether discretionary fiscal policy is expansionary or contractionary?

Question 26

Figure 13.1

Refer to Figure 13.1.All else equal,if the economy is in a recession,expansionary fiscal policy would result in a movement from

A) point A to point B.
B) point B to point A.
C) point B to point C.
D) point C to point B.

Question 27

Figure 13.1

Refer to Figure 13.1.All else equal,an increase in transfer payments would best be represented by a movement from

A) point A to point B.
B) point B to point A.
C) point B to point C.
D) point C to point B.

Question 28

An economic expansion tends to cause the federal budget deficit to ________ because tax revenues ________ and government spending on transfer payments ________.

A) increase; rise; falls
B) decrease; rise; falls
C) decrease; fall; rises
D) increase; fall; rises

Question 29

Explain the differences between discretionary fiscal policy and automatic stabilizers,and give one example of each.

Question 30

If the government is running a cyclically adjusted budget deficit,________ fiscal policy is ________ because aggregate expenditure is increasing.

A) discretionary; contractionary
B) discretionary; expansionary
C) expansionary; ineffective
D) contractionary; appropriate

Question 31

Identify whether each of the following policies is (1)an example of a discretionary fiscal policy,(2)an example of an automatic stabilizer,or (3)not a fiscal policy.
a. Food stamps
b. Government spending on rebuilding airports
c. Tax credits for the purchase of energy-efficient appliances
d. Changing the required reserve ratio
e. The progressive income tax system

Question 32

Figure 13.2

Refer to Figure 13.2.Assume the economy is initially in equilibrium with real GDP equal to potential GDP.Other things equal,the economy entering a recession would best be represented as a movement from ________ if there are no automatic stabilizers,and from ________ if there are automatic stabilizers.

A) point A to point B; point A to point C
B) point A to point C; point A to point B
C) point A to point B; point A to point C to point A
D) point A to point C; point A to point B to point A

Question 33

Figure 13.1

Refer to Figure 13.1.All else equal,an increase in corporate taxes would best be represented by a movement from

A) point A to point B.
B) point B to point A.
C) point B to point C.
D) point C to point B.

Question 34

The cyclically adjusted budget deficit or surplus measures what the deficit or surplus would be if the economy were

A) in the recession phase of the business cycle.
B) in the expansion phase of the business cycle.
C) at potential GDP.
D) no longer in a business cycle.

Question 35

Figure 13.1

Refer to Figure 13.1.All else equal,a decrease in government purchases would best be represented by a movement from

A) point A to point B.
B) point B to point A.
C) point B to point C.
D) point C to point B.

Question 36

If the economy is in a recession,the inflation rate is ________ it would be at potential GDP.Other things equal,if the government implemented an expansionary fiscal policy,the inflation rate would ________.

A) greater than; remain constant
B) greater than; decrease
C) less than; increase
D) less than; remain constant

Question 37

Suppose the federal budget deficit for the year was $500 billion and the economy were in a recession.If the economy had been at potential GDP,it is estimated that tax revenue would have been $350 billion higher and government spending on transfer payments would have been $200 billion lower.Using these estimates,the cyclically adjusted budget

A) deficit was $1050 billion.
B) deficit was $650 billion.
C) surplus was $50 billion.
D) surplus was $650 billion.

Question 38

Suppose the federal budget surplus for the year was $350 billion and the economy were in an economic expansion.If the economy had been at potential GDP,it is estimated that tax revenue would have been $140 billion lower and government spending on transfer payments would have been $50 billion higher.Using these estimates,the cyclically adjusted budget

A) deficit was $440 billion.
B) deficit was $260 billion.
C) surplus was $160 billion.
D) surplus was $540 billion.

Question 39

Figure 13.1

Refer to Figure 13.1.All else equal,a decrease in income taxes would best be represented by a movement from

A) point A to point B.
B) point B to point A.
C) point B to point C.
D) point C to point B.

Question 40

The gross federal debt refers to

A) the accumulation of past budget deficits.
B) government spending plus transfer payments minus tax revenues.
C) tax revenues minus government spending and transfer payments.
D) the total value of government bonds outstanding.

Question 41

Figure 13.2

Refer to Figure 13.2.Assume the economy is initially in equilibrium with real GDP equal to potential GDP.Other things equal,if the economy enters a recession,the inflation rate would ________ and the output gap would ________ if there are,as opposed to are not,automatic stabilizers in the economy.

A) decrease less; decrease less
B) decrease more; decrease more
C) decrease more; decrease less
D) not change; not change

Question 42

If the MPC is 0.9 and the tax rate is 15%,a $100 increase in autonomous investment will increase equilibrium income by

A) $131.
B) $426.
C) $599.
D) $850.

Question 43

Assume the economy is initially in equilibrium with real GDP equal to potential GDP.Other things equal,if the economy enters a recession and there are no automatic stabilizers,the IS curve would shift to the ________,and the shift would be equal to ________.

A) right; decline in investment spending
B) left; decline in investment spending
C) right; decline in investment spending times the multiplier
D) left; decline in investment spending times the multiplier

Question 44

C = $40 million + 0.6(1 - 0.2)Y
I = $35 million
G = $31 million
NX = -$6 million
Based on the above data,the equilibrium level of GDP is

A) $113.6 million.
B) $192.3 million.
C) $208.3 million.
D) $833.3 million.

Question 45

If the MPC is 0.75 and the tax rate is 10%,the expenditure multiplier will equal

A) 0.48.
B) 1.48.
C) 3.08.
D) 3.6.

Question 46

Figure 13.2

Refer to Figure 13.2.Assume the economy is initially in equilibrium with real GDP equal to potential GDP.Other things equal,if the economy enters a recession and the government underestimates the severity of the recession when implementing fiscal policy,the output gap will ________ and the rate of inflation will ________ than if the government had correctly estimated the recession's severity.

A) decrease less; decrease less
B) decrease more; decrease more
C) decrease more; decrease less
D) not change; not change

Question 47

If income taxes are incorporated into the discussion of the expenditure multiplier,the expenditure multiplier becomes

A) larger.
B) smaller.
C) zero.
D) negative.

Question 48

C = $5 million + 0.9(1 - 0.1)Y
I = $7 million
G = $6 million
NX = $1 million
Based on the above data,the equilibrium level of GDP is

A) $20.9 million.
B) $23.5 million.
C) $100 million.
D) $111.8 million.

Question 49

C = $40 million + 0.6(1 - 0.2)Y
I = $35 million
G = $31 million
NX = -$6 million
Based on the above data,the value of the expenditure multiplier is

A) 1.14.
B) 1.92.
C) 2.08.
D) 8.33.

Question 50

If the MPC is 0.8 and the tax rate is 20%,the expenditure multiplier will equal

A) 1.19.
B) 2.78
C) 4.0.
D) 6.0.

Question 51

Suppose the economy is in a recession and the government decides it needs to reduce the budget deficit.Other things equal,this would tend to

A) increase the output gap and make the recession worse.
B) decrease the output gap and make the recession worse.
C) help to eliminate the recession, but at the cost of a much higher inflation rate.
D) keep output from declining further, but increase the real interest rate and the inflation rate.

Question 52

Suppose you are paid a wage of $50 per hour.If your marginal income tax rate is 20%,then for every additional hour you work,your tax wedge is

A) $10.
B) $20.
C) $25.
D) $40.

Question 53

Suppose the economy is in a recession and the government decides it needs to reduce the budget deficit.Other things equal,this would tend to

A) shift the IS curve to the right.
B) shift the IS curve further to the left.
C) shift the MP curve further down.
D) shift the MP curve up.

Question 54

If the MPC is 0.6 and the tax rate is 20%,a $200 decrease in autonomous net exports will decrease equilibrium income by

A) $384.
B) $416.
C) $478.
D) $1666.

Question 55

The difference between the pretax and post-tax return to an economic activity is known as the

A) tax multiplier.
B) net tax.
C) tax burden.
D) tax wedge.

Question 56

Suppose you are paid a wage of $50 per hour.If your marginal income tax rate is 20%,then for every additional hour you work,your after-tax wage is

A) $10.
B) $20.
C) $25.
D) $40.

Question 57

Assume the economy is initially in equilibrium with real GDP equal to potential GDP.Other things equal,if the economy enters a recession and there are automatic stabilizers,the initial decrease in investment expenditure resulting from the recession is ________ what the decrease would be without automatic stabilizers,and the multiplier is ________ what the multiplier would be without automatic stabilizers.

A) less than; smaller than
B) greater than; larger than
C) equal to; smaller than
D) equal to; greater than

Question 58

If the MPC is 0.5 and the tax rate is 10%,a $500 increase in autonomous government purchases will increase equilibrium income by

A) $225.
B) $280.
C) $910.
D) $1110.

Question 59

C = $5 million + 0.9(1 - 0.1)Y
I = $7 million
G = $6 million
NX = $1 million
Based on the above data,the value of the expenditure multiplier is

A) 1.23.
B) 5.26.
C) 9.09.
D) 11.11.

Question 60

Assume the economy is initially in equilibrium with real GDP equal to potential GDP.Other things equal,if the economy enters a recession,automatic stabilizers

A) reduce the magnitude of the multiplier and reduce the size of the decline in real GDP.
B) reduce the decline in investment expenditures and therefore increase the real short-term interest rate.
C) cause any decrease in real GDP to be offset by an equal decrease in the inflation rate.
D) raise the interest rate to prevent the output gap from falling below equilibrium.

Question 61

Figure 13.3

Panel (a) Panel (b)
Refer to Figure 13.3.If exchange rates are floating,fiscal policy designed to reduce the federal deficit and the typical central bank response to the change in inflation caused by the fiscal policy would best be represented by a movement from ________ in panel (a)and a corresponding movement from ________ in panel (b).

A) point A to point D; point X to point Y
B) point C to point B; point X to point Y
C) point D to point A; point Y to point X
D) point B to point C; point Y to point X

Question 62

Under a fixed exchange rate system,an expansionary fiscal policy such as an increase in government expenditures will lead to a(n)________ in real GDP and a ________ inflation rate.

A) increase; higher
B) increase; lower
C) decrease; higher
D) decrease; lower

Question 63

Expenditure and tax multipliers are likely to be large

A) if the economy is experiencing deflation.
B) when real interest rates rise rapidly.
C) during severe recessions.
D) if the economy has negative cyclical unemployment.

Question 64

Briefly explain the effects on potential GDP of cutting each of the following taxes:
a. Individual income tax
b. Corporate income tax
c. Taxes on dividends and capital gains

Question 65

Under a fixed exchange rate system,an expansionary fiscal policy is

A) more effective in an open economy than in a closed economy.
B) less effective in an open economy than in a closed economy.
C) equally effective in an open economy and in a closed economy.
D) marginally effective in an open economy and completely ineffective in a closed economy.

Question 66

Figure 13.3

Panel (a) Panel (b)
Refer to Figure 13.3.If exchange rates are floating,an expansionary fiscal policy and the typical central bank response to the change in inflation caused by the fiscal policy would best be represented by a movement from ________ in panel (a)and a corresponding movement from ________ in panel (b).

A) point A to point D; point X to point Y
B) point C to point B; point X to point Y
C) point D to point A; point Y to point X
D) point B to point C; point Y to point X

Question 67

Three policy lags limit the effectiveness of monetary policy: recognition lags,implementation lags,and impact lags.Of these three policy lags,fiscal policy is impacted by

A) only implementation and impact lags.
B) only recognition and implementation lags.
C) only recognition and impact lags.
D) all three policy lags.

Question 68

C = $750 + 0.75(1 - 0.4)Y
I = $600
G = $500
NX = -$50
Use the above data to:
a. Calculate the equilibrium level of GDP.
b. Calculate the value of the expenditure multiplier.
c. Find the change in the initial equilibrium GDP if autonomous investment increases by $75.
d. Find the change in the initial equilibrium GDP if autonomous government purchases decreases by $50.
e. Find the change in the initial equilibrium GDP if autonomous net exports increase by $10.

Question 69

If exchange rates are floating,an expansionary fiscal policy in Canada will cause the dollar to ________ relative to other currencies and cause net capital outflows to ________.

A) appreciate; increase
B) appreciate; decrease
C) depreciate; increase
D) depreciate; decrease

Question 70

Crowding out is a reduction in private investment caused by government budget deficits,and may partially offset the expansionary effects of fiscal policy.The exact degree of crowding out depends on all of the following except

A) how much of the deficit is financed by households, firms, and governments outside of Canada.
B) how much real interest rates increase.
C) the level of the marginal corporate income tax rate.
D) the sensitivity of investment to the real interest rate.

Question 71

Suppose the economy is initially at full employment with real GDP equal to potential GDP.Use the IS-MP model and the Phillips curve to explain what happens if the economy experiences a recession both with and without automatic stabilizers.

Question 72

What are the effects of an expansionary fiscal policy on interest rates and output in an open economy with floating exchange rates?

Question 73

Forward-looking households may reduce consumption expenditures today if they believe that the government is currently

A) borrowing to run a budget deficit, and to pay back these loans in the future may require higher taxes.
B) running a budget surplus, and the increase in the government's supply of money will generate inflation in the future.
C) experiencing a balanced budget, and will therefore not be implementing any fiscal policy to stabilize the economy.
D) cutting federal spending to decrease the budget deficit, which will raise the real interest rate, the inflation rate, and the unemployment rate.

Question 74

Typically,discretionary fiscal policy changes have to be approved by the parliament so a detailed proposal needs to be put forward by the government; parliamentary approvement may take a significant amount of time.As a result,________ for fiscal policy can be several months longer than for monetary policy.

A) the response and recognition lags
B) the recognition lag
C) the response lag
D) all three policy lags

Question 75

There is no guarantee that after a tax cut households will immediately use their extra disposable income to consume more goods and services; they may maintain old spending patterns and change their spending slowly over time.As a result,the ________ for fiscal policy can last from several months to several years.

A) the response and recognition lags
B) the recognition lag
C) the impact lag
D) all three policy lags

Question 76

Briefly explain how policy lags related to the expansionary fiscal policy adopted by the Canadian government during the last recession.

Question 77

Expenditure and tax multipliers are likely to be large

A) when the inflation rate is close to zero.
B) if the central bank keeps real interest rates constant.
C) when the only unemployment in the economy is due to the natural rate of unemployment.
D) when real GDP exceeds potential GDP.