Question 1

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

Accepted Answer

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

Question 2

If taxes and government expenses did not vary with income, then income would:

Accepted Answer

A) be more stable. 
B) not be more or less stable. 
C) be less stable. 
D) be closer to potential income.

Question 3

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

Accepted Answer

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 4

When the economy entered a serious recession in 2008, the response of the U.S. government was to institute a $700 billion bailout plan, pursue other heavy deficit spending, and take on unusually large liabilities through bond and money market fund guarantees. This is an example of:

Accepted Answer

A) sound finance as fiscal policy. 
B) functional finance and expansionary fiscal policy. 
C) fiscal policy that employs automatic stabilizers as the primary means of economic stabilization. 
D) procyclical fiscal policy.

Question 5

As the economy expands, tax revenues:

Accepted Answer

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 6

Six key assumptions underlie models of fiscal policy.All of them are likely to be violated in the context of real world macroeconomic problems.Explain how any three of the following assumptions are likely to fail in the real world.
(a)Financing the deficit doesn't have any offsetting effects.
(b)The government knows what the current situation is.
(c)The government knows the economy's potential income level.
(d)The government has great flexibility in changing spending and taxes.
(e)The size of the government debt doesn't matter.
(f)Fiscal policy doesn't negatively affect other government goals.

Accepted Answer

The answer of Six key assumptions underlie models of fiscal...

Question 7

As income increases during the recovery from a recession, automatic stabilizers will:

Accepted Answer

A) increase taxes and increase government spending, increasing the overall size of the government. 
B) reduce taxes and increase government spending, accelerating the recovery. 
C) increase taxes and decrease government spending, slowing the recovery. 
D) reduce taxes on high-income individuals and raise taxes on the poor, increasing economic inequality.

Question 8

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?

Accepted Answer

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 9

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

Accepted Answer

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 10

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?

Accepted Answer

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 11

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

Accepted Answer

A) True 
 B)False

Question 12

Crowding out is associated with:

Accepted Answer

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 13

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

Accepted Answer

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

Question 14

The crowding out effect:

Accepted Answer

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 15

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:

Accepted Answer

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 16

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

Accepted Answer

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 17

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

Accepted Answer

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 18

Expansionary fiscal policy that raises the budget deficit may:

Accepted Answer

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 19

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:

Accepted Answer

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.

Exam 32: The Fiscal Policy Dilemma