Exam 15: Financial Crises, Stabilization, and Deficits

Suppose that government tax revenues are represented by the following algebraic equation: T = - 100 + .1Y. Assume that government spending is $280 billion and the economy is operating at $3000 billion. Calculate the size of the budget deficit.

Use the Economics in Practice titled "Financial Reform Bill" to answer the following question. What were the provisions of the Financial Reform Bill as described in the article as it applied to the use of market derivatives?

Explain the "balanced-budget amendment." Why are many economists who favor deficit reduction opposed to the balanced-budget amendment? Describe a condition in which a mandated balanced budget would be harmful to the nation's economic health.

What does the recognition lag imply about how well economic policy might work?

If an increase in government spending had a multiplier expanded effect upon GDP of $200 billion and the deficit response index is .15, calculate the amount by which the deficit will rise.

What is the deficit response index?

What happens to the deficit, when government spending is increased?

-Using the graph above, suppose it takes policy makers from time t2 to time t4 to take an action to stimulate the economy. What kind of policy lag is this and why does it happen?

Explain how deficit targeting can serve as an automatic destabilizer.

Explain why the implementation lag for fiscal policy is typically longer than for monetary policy.

Suppose the government is faced with a budget deficit of $50 billion. Explain why a cut in spending by precisely this amount may not balance the budget. What are the implications for policy if the goal is to balance the budget?

-Using the graph above, if economic policy causes aggregate demand curve shifts from AD2 to AD1, then what will happen to the equilibrium level of output and the price level? Explain.

Discuss the response lags for an expansionary monetary policy.

Explain how it is possible for the government budget deficit to rise or fall without Congress taking steps to change spending or taxes?

Explain why the implementation lag of fiscal policy is generally greater than the implementation lag of monetary policy.

What is a recognition lag?

Using Scenario 1, if GDP increases to $1.2 trillion, how much will the deficit change by? Explain.

What is the most important determinant of the response lag for monetary policy?

Explain why stagflation is a more difficult problem to solve for the Fed than others.

Explain why the time lags, in general, pose a challenge to policy makers.