Deck 14: Government Debt and Budget Deficits

Question 1

The large increase in U.S. government debt between 1980 and 1995 was unusual because it occurred:

A)during peacetime.
B)during an extended recessionary period.
C)without increased government spending.
D)without tax cuts.

Answer 1

during peacetime.

Question 2

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

Answer 2

$0.32 trillion

Question 3

One item that is considered part of the federal debt is:

A)Treasury bills.
B)future Social Security benefits.
C)student loans, which may go into default.
D)potential liabilities of savings and loan associations.

Answer 3

Treasury bills.

Question 4

The factors most responsible for forecasts of the U.S. government debt spiraling out of control in the next half century are the projected:

A)slowdowns in the rates of technological change and human capital growth.
B)decrease in high-skilled domestic workers and the increase in immigration of low-skilled workers into the United States.
C)aging of the U.S. population and rising health care costs.
D)increase in international competition and the outsourcing of U.S. jobs.

Question 5

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 favor high interest rates on their savings.
D)governments spend more on education as the proportion of the elderly increases.

Question 6

If the debt of the U.S. federal government 2009, were divided equally among the people in the United States, then the debt per person would equal approximately:

A)$2,500.
B)$25,000.
C)$25.00.
D)$250,000.

Question 7

A deficit adjusted for inflation should include only government spending to pay interest payments.

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

Question 8

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 9

If the preferred bank stock acquired by the U.S. government through the TARP program is valued using a capital budgeting approach, then the government budget deficit in the year in which the stocks were acquired will be than if a current expenditure approach were employed.

A)larger
B)smaller
C)no different
D)more cyclical

Question 10

Relative to the size of GDP U.S. federal government debt was at its maximum:

A)at the end of the Revolutionary War.
B)at the end of the Civil War.
C)at the end of World War II.
D)following the 9/11 terrorist attacks in 2001.

Question 11

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 12

Historically, the primary cause of increases in government debt is:

A)printing too much money.
B)cutting taxes.
C)increasing interest rates.
D)financing wars.

Question 13

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

Question 14

Compared to The Size of the Government debt as a percentage of GDP in other major industrial countries, the federal government of the United States:

A)is one of the most heavily indebted governments.
B)has accumulated a relatively small debt.
C)has debt ranked about midway between the most and least heavily indebted governments.
D)is one of the least indebted governments.

Question 15

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 16

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 17

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 18

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 19

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 20

The government budget deficit is the , and government debt is the .

A)amount by which imports exceed exports; amount by which government spending exceeds government revenue
B)amount by which government spending exceeds government revenue; amount by which imports exceed exports
C)amount by which government spending exceeds government revenue; accumulation of past government borrowing
D)accumulation of past government borrowing; amount by which government spending exceeds government revenue

Question 21

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 22

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

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

Question 23

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

A)stimulates consumer spending and reduces national saving.
B)stimulates consumer spending 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 24

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 25

According to the traditional view, a tax cut without a cut in government spending:

A)raises consumption in both the short run and the long run.
B)lowers consumption in both the short run and the long run.
C)raises consumption in the short run but lowers it in the long run.
D)lowers consumption in the short run but raises it in the long run.

Question 26

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

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

Question 27

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 28

According to the traditional view (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 29

According to the traditional view, 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 30

According to the traditional view, 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 31

According to the traditional view, 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

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 33

The debt of the United States 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 Social Security benefits.
D)government guarantees of student loans.

Question 34

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 35

An estimate of what government spending and tax revenue would be if the economy were operating at its natural rate of output and employment is called the budget.

A)cyclically adjusted
B)inflation-adjusted
C)capital asset
D)generational accounting

Question 36

Measuring The Size of the Government debt is complicated by all of the following factors except:

A)inflation.
B)uncounted liabilities.
C)capital assets of the government.
D)failure of the Office of Management and Budget to disclose figures on capital expenditures and credit programs.

Question 37

The international impacts of a debt-financed tax cut, according to the traditional view, are a(n) in net exports and a domestic currency .

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

Question 38

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

A)decreases in aggregate supply.
B)increases in aggregate supply.
C)decreases in the money supply.
D)increases in the money supply.

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 tax payers.
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

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 43

According to the theory of Ricardian equivalence, if consumers are forward-looking, they will view a tax cut that has 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 44

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 45

The strategic bequest motive hypothesizes that parents:

A)leave bequests to children because they care about their children's well-being.
B)leave bequests to children who are borrowing-constrained.
C)make larger bequests the larger the quantity of taxes that will be shifted to their children.
D)use the threat of disinheritance to control their children's behavior.

Question 46

The Ricardian view on fiscal policy makes less sense if people are:

A)rational and foresighted.
B)shortsighted and not fully rational.
C)able to plan for the future.
D)able to borrow without constraint.

Question 47

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 48

The experience of the 1980s:

A)clearly contradicted the Ricardian equivalence view because national saving was very low.
B)clearly supported the Ricardian equivalence view, for people saved little only because they were optimistic, as confirmed by the stock market.
C)will provide a clear Answer on the validity of Ricardian equivalence as soon as economists are able to analyze it with their computers.
D)may be used to argue both in favor of and against the Ricardian equivalence view of the tax cuts.

Question 49

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 even 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 50

Proponents of Ricardian equivalence argue that the relevant decisionmaking unit is the:

A)individual.
B)household.
C)infinitely lived family.
D)community.

Question 51

In the United States, a balanced budget is currently in force for:

A)the federal government.
B)no state governments.
C)all state governments.
D)many state governments.

Question 52

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 53

Proponents of Ricardian equivalence argue that if taxes are cut without cutting government spending, and taxes are not expected to increase in the future until after an individual expects to be dead, then the individual will:

A)spend all of the increase in income.
B)spend some of the increase in income and save the rest.
C)use the increase in income to buy government bonds to help finance the deficit.
D)save all of the increase in income and leave it as a bequest to his or her children.

Question 54

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 55

From the Ricardian point of view, a consumer should not raise his or her consumption when taxes are cut but government spending is not cut because:

A)the government is going to raise taxes by exactly as much as the cut in the next year.
B)the government is going to raise taxes by exactly as much as the cut plus interest in the next year.
C)the government is sure to raise taxes by an amount equal in present value to the debt incurred this year, sometime in the taxpayer's lifetime.
D)even if the government does not raise enough extra taxes during the taxpayer's lifetime to pay

Question 56

All of the following are arguments against Ricardian equivalence except consumers:

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

Question 57

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 58

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

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

Question 59

When President George Bush lowered tax withholding 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 60

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 61

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 62

The U.S. Treasury 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 63

If the government levies a one-time temporary tax on the young and gives the proceeds to the elderly, and both generations follow the life-cycle consumption pattern but are not altruistically linked:

A)both the young and the old will consume more.
B)there will be a net increase in overall consumption.
C)there will be a net decrease in overall consumption.
D)there will be no change in overall consumption.

Question 64

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

Question 65

If an individual should subtract the present value of future tax obligations due to the government deficit from his or her disposable income, this situation suggests that, in aggregate analysis, the government deficit should be subtracted from disposable income. That is, instead of C = a + b(Y - T), we should use:
C = a + b((Y - T - (G - T)), or
= a + b(Y - G).
a. Using this consumption function and the further relations:
I = I
G = G T = T
Y = C + I + G
write the equilibrium equation determining Y as a function of a, I, G, and T.
b. If b equals 0.5, what are the numerical values of the multipliers for I, G, and T, respectively?

Question 66

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

Question 67

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 68

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 69

The real value of government debt is reduced by:

A)expected inflation.
B)expected deflation.
C)unexpected inflation.
D)unexpected deflation.

Question 70

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 71

Inflation-indexed government bonds have all of the following benefits except:

A)eliminating inflation.
B)reducing the government's incentive to produce surprise inflation.
C)encouraging financial innovation.
D)eliminating inflation risk.

Question 72

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

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

Question 73

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

Question 74

A measure of the expected rate of inflation can be found by the:

A)yield on index bonds plus the yield on nominal bonds.
B)yield on index bonds minus the yield on nominal bonds.
C)observed rate of inflation minus the yield on real bonds.
D)observed rate of inflation minus the yield on nominal bonds.

Question 75

A strict balanced-budget rule would:

A)permit the use of fiscal policy for stabilization.
B)allow the use of tax smoothing to reduce tax distortions.
C)redistribute tax burdens across generations.
D)restrain political incompetence and opportunism.

Question 76

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 77

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 78

Indexed bonds produce all of the benefits except:

A)less inflation risk.
B)more financial innovation.
C)better government incentives.
D)lower rates of inflation.

Question 79

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 80

If the government levies a one-time temporary tax on the young and gives the proceeds to the elderly, and both generations follow the life-cycle consumption pattern and are altruistically linked:

A)both the young and the old will consume more.
B)there will be a net increase in overall consumption.
C)there will be a net decrease in overall consumption.
D)there will be no change in overall consumption.