Deck 17: Government Debt and Budget Deficits

Question 1

In a time of inflation when the government budget is balanced in the conventional sense, the real (i.e., deflated) value of the government debt is:

A)growing at the rate of inflation.
B)growing but at a rate less than the rate of inflation.
C)constant.
D)decreasing at the rate of inflation.

Answer 1

decreasing at the rate of inflation.

Question 2

According to the textbook, a "fiscal dividend" exists:

A)when income taxes are increased.
B)when the Canadian government runs large budget deficits.
C)during a period of debt reduction as new room is created in the budget as the debt to GDP ratio falls.
D)when the Canadian government increases government spending and the size of the budget deficit.

Answer 2

during a period of debt reduction as new room is created in the budget as the debt to GDP ratio falls.

Question 3

The large increase in Canadian debt in the 1970s and 1980s occurred because:

A)the average growth for real GDP fell during that period.
B)Canada was involved in many wars.
C)the Canadian government ran large surpluses.
D)the Canadian government increased taxes and reduced spending.

Answer 3

the average growth for real GDP fell during that period.

Question 4

If government debt is not changing, then:

A)the economy is at long-run equilibrium.
B)the government's budget must be balanced.
C)GDP must equal the natural rate of output.
D)capital per worker is constant.

Question 5

Holding other factors constant, the ratio of government debt to GDP can decrease as a result of any of the following changes except:

A)decreases in government spending.
B)increases in GDP.
C)decreases in tax revenues.
D)decreases in transfer payments.

Question 6

Compared to the size of government debt as a percentage of GDP in other major industrial countries, the Canadian federal government:

A)is one of the most heavily indebted governments.
B)has accumulated no debt.
C)is one of the least indebted governments.
D)has accumulated somewhat greater than average debt.

Question 7

The amount by which government spending exceeds government revenues is called the _____, and the accumulation of past government borrowing is called the _____.

A)deficit; debt
B)debt; deficit
C)devaluation; deflation
D)deflation; devaluation

Question 8

When a government spends more than it collects in taxes, it runs a:

A)trade deficit.
B)trade surplus.
C)budget surplus.
D)budget deficit.

Question 9

Government debt equals the:

A)difference between current government purchases and taxes.
B)difference between saving and investment.
C)sum of past budget deficits and surpluses.
D)M1 money supply.

Question 10

Assume that the nominal interest rate is 11 percent, the inflation rate is 8 percent, and government debt at the beginning of the year equals $4 trillion. By how much is the government budget deficit overstated as a result of inflation?

A)$0.12 trillion
B)$0.32 trillion
C)$0.44 trillion
D)$0.80 trillion

Question 11

A deficit adjusted for inflation should include only government spending used to make _____ interest payments.

A)real
B)nominal
C)foreign
D)domestic

Question 12

An increase in the elderly population of a country affects fiscal policy most directly because:

A)the elderly generally are not required to pay taxes.
B)governments provide pensions and health care for the elderly.
C)the elderly favour high interest rates on their savings.
D)governments spend more on education as the proportion of the elderly increases.

Question 13

When the federal government incurs additional debt to acquire an asset, under current budgeting procedures the deficit _____, while under capital budgeting procedures the deficit _____.

A)does not change; increases
B)increases; does not change
C)does not change; decreases
D)decreases; does not change

Question 14

Capital budgeting is a procedure that:

A)adjusts the deficit for inflation.
B)estimates what the deficit would be if the economy were operating at the natural rate of output.
C)accounts for assets as well as liabilities.
D)measures the impact of fiscal policy on the lifetime incomes of individuals of different ages.

Question 15

In a time of inflation when the real (i.e., deflated) value of the government debt is constant, the conventionally:

A)reported government budget will show a deficit equal to the inflation rate times the outstanding debt.
B)reported government budget will show a deficit equal to less than the inflation rate times the outstanding debt.
C)reported government budget will be balanced.
D)measured government budget will show a surplus equal to the inflation rate times the outstanding debt.

Question 16

Current measures of the Canadian federal government's budget deficit account for all of the following except:

A)government expenditures.
B)government revenues.
C)changes in government indebtedness.
D)changes in government capital assets.

Question 17

If capital budgeting procedures were employed, then a budget deficit would be measured as:

A)the sum of government debt.
B)the change in government debt.
C)the change in government debt minus the change in government capital assets.
D)the change in government capital assets.

Question 18

All of these statements are correct, EXCEPT:

A)The Canadian debt to GDP ratio increased significantly during World War II.
B)The Canadian government recorded many budget surpluses from 1945 to 1970.
C)The Canadian government ran large budget deficits in the 1970s and 1980s.
D)The Canadian government has balanced the budget since 2000.

Question 19

If the debt of the Canadian federal government in 2017 was divided equally among the people in Canada, then the debt per person would equal approximately:

A)$4,400.
B)$17,250.
C)$73,350.
D)$153,250.

Question 20

If the government debt, D, equals $5 trillion, the nominal interest rate is 7 percent, and the real interest rate is 3 percent, then nominal budget deficit overstates the real deficit by $ _____ trillion.

A)0.35
B)0.20
C)0.15
D)0.07

Question 21

According to the traditional viewpoint of government debt, a tax cut without a cut in government spending:

A)stimulates consumer spending in the short run and reduces national saving.
B)stimulates consumer spending in the short run and reduces private saving.
C)has no effect on consumer spending but reduces national saving.
D)has no effect on consumer spending but reduces private saving.

Question 22

Under capital budgeting, all of the following transactions would affect the federal budget deficit except the federal government's:

A)sending a cheque to a recipient of social assistance.
B)sending a cheque to the Government of Ontario.
C)selling a highway to the Government of Ontario and using the proceeds to retire federal debt.
D)selling an office building.

Question 23

According to the traditional view of government debt, if taxes are cut without cutting government spending, then the short-run effects will be:

A)higher output and lower unemployment.
B)higher output and higher unemployment.
C)no change in output or unemployment.
D)no change in output and higher unemployment.

Question 24

The logic of Ricardian equivalence implies that:

A)tax cuts do not influence consumer spending but changes in government spending do.
B)neither tax cuts nor changes in government spending affect consumer spending.
C)tax cuts combined with future decreases in government spending will decrease consumer spending.
D)if the government cuts taxes and increases current government spending, consumer spending will increase.

Question 25

The cyclically adjusted budget deficit:

A)adjusts the deficit for inflation.
B)estimates what the deficit would be if the economy were operating at the natural rate of output.
C)accounts for assets as well as liabilities.
D)measures the impact of fiscal policy on the lifetime incomes of individuals of different ages.

Question 26

According to the traditional view of government debt, if taxes are cut without cutting government spending, then the long-run effects will be _____ steady-state capital and _____ consumption.

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

Question 27

Government tax policy can affect aggregate supply as well as aggregate demand because changes in taxes change the:

A)supply of money in the economy.
B)length of the inside lag of fiscal policy.
C)incentives to work and invest.
D)tradeoff between inflation and unemployment.

Question 28

Ricardian equivalence refers to the same impact of financing government:

A)whether by printing money or raising taxes.
B)in the long run as in the short run.
C)whether by debt or taxes.
D)in an open economy as in a closed economy.

Question 29

According to the traditional view of government debt, if taxes are cut without a cut in government spending, then in Canada this situation will lead to _____ net indebtedness on the part of Canada to foreign countries and _____ net exports.

A)more; more
B)more; fewer
C)less; fewer
D)less; more

Question 30

According to the traditional view of government debt (as in the IS-LM model), if taxes are cut without cutting government spending, then in the short run interest rates will _____, and investment will ______.

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

Question 31

According to the traditional view of government debt (as in the Mundell-Fleming model), if taxes are cut without cutting government spending, then the short-run effects are a(n) _____ of the dollar and a(n) _____ in net exports.

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

Question 32

The debt of the Canadian government is underreported in the view of many economists because all of the following liabilities are excluded except:

A)future pensions of government employees.
B)debt owed to foreigners.
C)future Canada Pension Plan benefit payments.
D)government guarantees of student loans.

Question 33

According to the theory of Ricardian equivalence, if consumers are forward-looking, they will view a tax cut combined with no plans to reduce government spending as _____, so their consumption will _____.

A)additional disposable income; increase
B)additional disposable income; remain unchanged
C)a rescheduling of taxes into the future; increase
D)a rescheduling of taxes into the future; remain unchanged

Question 34

Each of the following changes would allow the measured budget deficit to provide a truer picture of fiscal policy except:

A)correcting for the effects of inflation.
B)offsetting changes in government liabilities with changes in government assets.
C)excluding some liabilities altogether.
D)correcting for the effects of the business cycle.

Question 35

According to the theory of Ricardian equivalence, tax cuts combined with no plans to reduce government spending _____ public saving and _____ private saving.

A)reduce; reduce
B)reduce; increase
C)increase; increase
D)increase; reduce

Question 36

According to the traditional view of government debt, if taxes are cut without cutting government spending, then the international effect initially will be a capital _____ and a trade _____.

A)inflow; deficit
B)inflow; surplus
C)outflow; deficit
D)outflow; surplus

Question 37

According to supply siders, tax cuts can raise total tax revenue if the tax cuts generate large enough:

A)decrease in aggregate supply.
B)increase in aggregate supply.
C)decrease in the money supply.
D)increase in the money supply.

Question 38

The amount the government would owe if a borrower were to default on a government-guaranteed loan is an example of:

A)capital budgeting.
B)a contingent liability.
C)a cyclically adjusted liability.
D)Ricardian equivalence.

Question 39

Assume that a government has a balanced budget when the economy is at full employment. If the economy then enters a recession, with no change in tax or spending laws, then the budget of the government is most likely to:

A)remain balanced.
B)be in deficit.
C)be in surplus.
D)be in either deficit or surplus, depending on the severity of the recession.

Question 40

Cyclically adjusted budgets are useful because they:

A)systematically account for changes in government assets and liabilities.
B)reflect policy changes but not current economic conditions.
C)account for tax burdens on different generations of taxpayers.
D)correctly account for the impact of inflation on government indebtedness.

Question 41

One way to shift the tax burden from the current generation to future generations is to finance a war:

A)by raising taxes.
B)by printing money.
C)by running a budget surplus.
D)by running a budget deficit.

Question 42

Financing a budget deficit by _____ leads to inflation, and inflation _____ the real value of government debt.

A)issuing debt; increases
B)issuing debt; decreases
C)printing money; increases
D)printing money; decreases

Question 43

In response to a tax cut, the consumption of a consumer who is borrowing constrained _____, whereas the consumption of a forward-looking, unconstrained consumer acting in accord with Ricardian equivalence _____.

A)increases; increases
B)increases; remains unchanged
C)remains unchanged; remains unchanged
D)remains unchanged; increases

Question 44

Suppose a household considers only current income in making consumption decisions. This is an example of:

A)Ricardian equivalence.
B)the permanent-income hypothesis.
C)myopia.
D)the life-cycle model.

Question 45

Using fiscal policy, including automatic stabilizers, to stabilize output over a business cycle is not consistent with:

A)rational expectations.
B)inflation targeting.
C)the natural-rate hypothesis.
D)a strict balanced-budget rule.

Question 46

All of the following are arguments against Ricardian equivalence except:

A)consumers make consumption decisions myopically.
B)consumers are rational and forward-looking in consumption decision-making.
C)consumers are borrowing constrained.
D)consumers do not expect future taxes to fall on them.

Question 47

Assume that nobody cares about the economic well-being of future generations. Then the Ricardian equivalence view of the effect of debt-financed tax cuts is:

A)totally invalid.
B)still fully valid because the government has the option to levy taxes to pay off the full debt in just a few years.
C)still fully valid as long as the government cuts spending also.
D)still partially valid because most of the taxpayers will live and pay taxes for a substantial number of years after the tax cut.

Question 48

A debt-financed tax cut will _____ saving in the traditional view and _____ saving in the view of Ricardian equivalence.

A)increase; increase
B)decrease; decrease
C)decrease; increase
D)decrease; not change

Question 49

To force politicians to judge whether government spending is worth the costs, some economists have argued for:

A)a balanced-budget rule for fiscal policy.
B)a constant money-growth rule for monetary policy.
C)avoiding the assumption of any contingent liabilities.
D)the application of Ricardian equivalence.

Question 50

In Canada, most provinces repealed their balanced budget legislation because:

A)they were forced by the federal government to do so.
B)they were forced by the IMF to do so.
C)Canadians in these provinces voted in favour of a referendum for not balancing the budget.
D)there are times where governments have to run budget surpluses or deficits.

Question 51

High levels of government debt that raise investors' fear of a government default on debt will result in capital _____ and a(n) _____ of the country's exchange rate.

A)outflows; depreciation
B)outflows; appreciation
C)inflows; depreciation
D)inflows; appreciation

Question 52

Hyperinflations typically occur when governments:

A)attempt to keep the unemployment rate below the natural rate.
B)finance spending with the inflation tax.
C)set inflation targets too high.
D)use discretionary monetary policy to stabilize output.

Question 53

One reason for not requiring a balanced federal budget at all times is that with a balanced-budget rule:

A)expenditures are not limited because, if the government wants to raise expenditures, it just raises taxes.
B)in a recession the automatic stabilizing powers of our system of taxes and transfers could not work.
C)the distorting features of the tax system are minimized.
D)it is possible to shift the burden of a war from current to future generations.

Question 54

The possibility of capital flight is likely to be greater at higher levels of government debt because there is a greater:

A)temptation to default on the debt.
B)likelihood that the government will begin issuing indexed bonds.
C)probability that a balanced budget will be adopted by the government.
D)potential for tax smoothing policies to be eliminated.

Question 55

To minimize the disincentives of very high taxes, a policy of tax smoothing requires a budget _____ in years of unusually low government revenue and a budget _____ in years of unusually high government expenditures.

A)surplus; deficit
B)deficit; surplus
C)surplus; surplus
D)deficit; deficit

Question 56

Monetary policy is linked to fiscal policy when government spending is financed by:

A)taxes.
B)borrowing from banks.
C)borrowing from foreigners.
D)printing money.

Question 57

Given a reduction in income tax withheld, but no change in income tax owed, households that act according to Ricardian equivalence would _____ the extra take-home pay, while those facing binding borrowing constraints would _____ the extra-take home pay.

A)spend; spend
B)spend; save
C)save; save
D)save; spend

Question 58

When U.S. President George H. W. Bush lowered tax withholding in the United States in 1992 without lowering the amount of taxes owed, surveys showed that:

A)almost everyone spent the higher take-home pay.
B)almost everyone saved the higher take-home pay.
C)a majority of respondents said they would spend the higher take-home pay, but a significant minority said they would save it.
D)a majority of respondents said they would save the higher take-home pay, but a significant minority said they would spend it.

Question 59

Tax smoothing is a desirable policy because it:

A)reduces the distortions of incentives caused by taxes.
B)reduces budget deficits in periods of recession.
C)eliminates the impact of automatic stabilizers.
D)is consistent with a balanced budget.

Question 60

A debt-financed tax cut will _____ current consumption in the traditional view and _____ current consumption in the view of Ricardian equivalence.

A)increase; increase
B)increase; decrease
C)increase; not change
D)decrease; decrease

Question 61

A country with total debt of $500 million has a nominal interest rate of 10 percent and a real interest rate of 6 percent. Is the budget deficit of the country underestimated or overestimated, and by how much?

Question 62

In 2018, Canada's budget deficit was approximately $18 billion (about one percent of GDP). Some economists say that this deficit is understated. Why do they say this?

Question 63

What is Ricardian equivalence? Give at least three reasons Ricardian equivalence might not correctly describe an economy.

Question 64

Spending more than earning will always cause a deficit in the budget and is always considered a bad thing. Is there a possibility that a budget deficit in any economy can have some advantages, too? Give two examples of these advantages, if any.

Question 65

The government of Moneyland decides that it is not going to change its spending but will decrease the taxes. According to the theory of Ricardian equivalence, what will be the effects of the government action on national saving?

Question 66

Many people are concerned about the current budget deficit of the Canadian government. Suggest at least three possible negative economic effects of a budget deficit and three possible economic benefits of a budget deficit.

Question 67

War is the generator of debt burden for countries. How does war generate debt for a country?

Question 68

The Department of Finance Canada reports the budget deficit or surplus of the federal government. Give at least one reason why the measured budget deficit might overstate the "true" deficit and at least one reason the measured figure might understate the "true" deficit.

Question 69

"The baby-boom generation (people born between 1946 and 1965) is responsible for pushing the Canadian economy into more debt." Is this statement true or false? Give reasons supporting your answer.

Question 70

Graphically illustrate the traditional view of the short-run impacts of a debt-financed tax cut on:
a.interest rates and output in a closed economy in the short run, using the IS-LM model.
b.exchange rates and output in a small open economy with a flexible exchange rate in the short run, using the Mundell-Fleming model.

Question 71

Using the model of aggregate demand-aggregate supply to illustrate the traditional view, graphically compare the short-run and long-run impact of debt-financed tax cuts on:
a. output.
b. prices.

Question 72

Graphically illustrate the traditional view of the long-run impacts of a debt-financed tax cut on:
a.saving, investment, and real interest rate using the classical model (Chapter 3).
b.steady state capital per worker and output per worker using the Solow growth model.

Question 73

Compare the traditional view versus the view of Ricardian equivalence of the effects of a debt-financed tax cut on:
a.national saving.
b.current consumption.
c.the real interest rate.

Question 74

Explain how tax cuts can affect both aggregate demand and aggregate supply.

Question 75

Printing money increases inflation. The higher the inflation, the lower the real value of debt. So why is this method not used to pay debts?