Question 1

The Ricardian equivalence theorem is correct if two assumptions are true. These assumptions are that people have:

Accepted Answer

The Ricardian equivalence theorem posits that consumers are forward-looking and thus understand that government deficits today will lead to increased taxes in the future. For this theorem to hold, it is crucial that individuals have access to savings instruments to adjust their savings in anticipation of future tax increases.

Question 2

According to the Ricardian equivalence theorem, people increase savings today when the government increases deficits because they recognize that:

Accepted Answer

The Ricardian equivalence theorem posits that when the government increases deficits, individuals anticipate that this will lead to higher taxes in the future to pay off the debt. As a result, they increase their savings to prepare for these future tax burdens.

Question 3

Automatic stabilizers are government programs or policies that will counteract the business cycle without any new government action.

Accepted Answer

Automatic stabilizers are built into the economy and automatically adjust to counteract economic fluctuations to stabilize the economy, such as unemployment benefits and progressive taxation, without the need for new government intervention.

Question 4

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

Accepted Answer

According to the Ricardian equivalence theorem, individuals anticipate that government deficits today will lead to increased taxes in the future. As a result, they save more in anticipation of these future taxes, offsetting the impact of current government spending on the economy. This behavior suggests that government deficits do not affect the overall level of output because any increase in government spending is matched by an increase in private savings.

Question 5

Sound finance holds that government spending should be directed toward sound investment.

Accepted Answer

The answer of Sound finance holds that government spending should...

Question 6

The concept of fiscal policy refers to the:

Accepted Answer

Fiscal policy involves government decisions on taxation and spending to influence the economy. Running a deficit (spending more than the revenue) or a surplus (spending less than the revenue) can stimulate or slow down economic activity, respectively, affecting the level of output in the economy.

Question 7

According to the Ricardian equivalence theorem, people increase savings when the government increases deficits because they recognize the link between government deficits and higher future taxes.

Accepted Answer

The Ricardian equivalence theorem posits that consumers anticipate that higher government deficits today will lead to higher taxes in the future to pay off the debt, and thus, they increase their savings to prepare for this future tax burden.

Question 8

Which of the following best describes most economists' approach to economic stabilization until the 1930s?

Accepted Answer

Before the 1930s, the prevailing economic philosophy among economists was to maintain a balanced budget at all times, adhering to the principle of sound finance. This approach was challenged and evolved with the development of Keynesian economics during and after the Great Depression.

Question 9

If the government knew the level of potential income and had sufficient information about the economy it could fine-tune the economy.

Accepted Answer

While having detailed information about potential income and the economy can help the government make informed decisions, the complexity and unpredictability of economic factors make it impossible to fine-tune the economy perfectly. External shocks, market psychology, and the delayed effects of policy interventions are among the challenges that prevent precise economic fine-tuning.

Question 10

The elimination of automatic stabilizers would decrease the need for other fiscal policies.

Accepted Answer

Automatic stabilizers, such as unemployment benefits and progressive taxes, help to moderate the fluctuations in an economy by automatically increasing spending or decreasing taxes during economic downturns and vice versa during upturns. Eliminating them would likely increase the need for discretionary fiscal policies to address economic fluctuations.

Question 11

The theoretical proposition that government deficits do not affect the level of output because individuals realize that they have to pay the deficits in the future, and therefore increase their savings now, is called:

Accepted Answer

The Ricardian equivalence theorem posits that government budget deficits do not affect the total level of demand in an economy because individuals anticipate future taxes to pay off the deficits and thus save more to offset their future tax liabilities, leaving overall spending unchanged.

Question 12

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

Accepted Answer

The Ricardian equivalence theorem posits that consumers anticipate the need to pay off government deficits in the future through higher taxes, leading them to increase their savings now to prepare for those future tax increases. This offsets the direct impact of government spending on the economy, neutralizing the effect of deficits on the overall level of output.

Question 13

The view that the government budget should always be balanced except in wartime refers to:

Accepted Answer

The view that the government budget should always be balanced except in wartime is referred to as "sound finance." This principle advocates for fiscal responsibility and caution in budget management, except under extraordinary circumstances such as war.

Question 14

Economists who believe in sound finance would say that in a recession, the government should:

Accepted Answer

Economists who believe in sound finance prioritize maintaining a balanced budget for political and moral reasons, even during a recession.

Question 15

Financing expansionary fiscal policy by increasing the deficit does not generally affect interest rates.

Accepted Answer

Financing expansionary fiscal policy by increasing the deficit can lead to higher interest rates because the government borrows more, potentially crowding out private investment and increasing demand for loanable funds.

Question 16

The government's running of a deficit or a surplus with the objective of affecting the level of output in the economy is called:

Accepted Answer

Fiscal policy involves the government's use of its budget through spending and taxation to influence the overall level of economic activity, including efforts to adjust the economy's output.

Question 17

Crowding out is the offsetting effect on private expenditures caused by the government's sale of bonds to finance expansionary fiscal policy.

Accepted Answer

Crowding out occurs when government spending increases, leading to higher demand for borrowing. This increase in borrowing can raise interest rates, making it more expensive for the private sector to borrow and invest, thus potentially reducing private expenditure in the economy.

Question 18

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

The Ricardian equivalence theorem suggests that it doesn't matter whether a government finances its spending with debt or taxes because the effect on the total level of demand in the economy will be the same. Economists who accepted this as theoretically true could argue for sound finance (balancing the budget) because it avoids debt accumulation, or for functional finance (using fiscal policy to manage demand), believing that the method of financing (debt or taxes) doesn't affect the economy's total demand, allowing for flexibility in policy to achieve economic objectives.

Question 19

The application of Keynesian economics to public finance and fiscal policy by Abba Lerner, and its incorporation into Paul Samuelson's economic principles textbook, was known as procyclical finance.

Accepted Answer

The application of Keynesian economics to public finance and fiscal policy by Abba Lerner, and its incorporation into Paul Samuelson's economic principles textbook, is known as functional finance, not procyclical finance. Functional finance is focused on achieving full employment and stable prices, rather than aiming for a balanced budget.

Question 20

The 2008-2009 deficit stimulus spending by the federal government is an example of expansionary sound finance.

Accepted Answer

The 2008-2009 deficit stimulus spending by the federal government is an example of expansionary fiscal policy, aimed at stimulating the economy during a downturn, not necessarily "sound finance," which implies a more conservative approach to fiscal management.

Quiz 32: The Fiscal Policy Dilemma