Exam 15: Financial Crises, Stabilization, and Deficits

Assume an economy with a budget deficit of $50 billion. Suppose the income multiplier is 1.5 and the deficit response index is .20. Calculate the new budget deficit if Congress cuts spending by the exact amount of the budget deficit.

Assume that the economy is in a recession. If the government were to increase spending while the Fed expanded the money supply, what would be the effect on interest rates and investment? Explain why your answer is likely to be ambiguous.

What would be the Federal Reserve's expansionary response to offset the effects of a decrease in government spending?

What might be the most prudent way to cut a large budget deficit if the government is concerned about driving the economy into recession?

Assume an economy where the deficit response index is zero. If the budget deficit is $85 billion and the multiplier is 4 how much must government spending be cut in order to drive the deficit to zero? What role does the multiplier play in the solution to this problem?

What is the NASDAQ composite?

What part of the Gramm-Rudman-Hollings Act were determined by the Supreme Court to be unconstitutional.

What is a negative demand shock?

According to the book how did the FED respond to the stock market boom between 1995 and 2000?

Why does a stock market boom reduce saving?

Why might it be imprudent for policy makers to try to cut a large government budget deficit all in one year?

To what extent can monetary policy ease the macroeconomic effects of any budget that calls for a reduction in government spending or increase in taxes? Explain.

Using Scenario 1, if GDP decreases to $ 9.8 trillion, how much will the deficit change by? Explain.

Explain stagflation and the policy dilemma it presents.

-Use the graph above to explain what will happen if an expansionary policy that should have begun to take effect at point A does not actually begin to have an impact until point D, when the economy is already on an upswing.

What are automatic stabilizers?

Explain the use of stabilization policy.

Suppose government spending is reduced by $100 billion. Explain what effect this reduction in government spending will have on the size of a budget deficit. Specifically, does the deficit increase or decrease? And, is any change in the deficit equal to, larger than, or smaller than $100 billion?

How and why does the stock market and housing market affect consumption?

-Using the graph above, if the economy is currently at Point B and policy makers implement a policy which shifts the aggregate demand curve to AD1, identify the lag that refers the amount of time necessary for the economy to react to this change.