Question 1

According to most economists, fiscal policy is:

Accepted Answer

Fiscal policy, which involves government spending and taxation, is often debated among economists regarding its effectiveness in fine-tuning the economy. Many argue that due to delays in implementation and effects, it is not an effective tool for making precise adjustments to economic conditions.

Question 2

When the government runs a deficit, the interest rate tends to:

Accepted Answer

When the government runs a deficit, it typically borrows money, increasing the demand for loanable funds, which tends to push interest rates up.

Question 3

Refer to the graph shown. Expansionary fiscal policy is most likely to shift the aggregate demand curve from:

Accepted Answer

The answer of Refer to the graph shown. Expansionary fiscal...

Question 4

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

Restricting credit growth is a tool of contractionary monetary policy, aimed at reducing the money supply and slowing down the economy. This does not directly involve government spending or taxation adjustments, which are tools of fiscal policy.

Question 5

Functional finance is:

Accepted Answer

Functional finance is a theoretical proposition that suggests government fiscal policy should be used to achieve full employment and price stability, without moral considerations about budget deficits or surpluses.

Question 6

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

Accepted Answer

Functional finance advocates for a government's active role in managing the economy through spending and taxing decisions, aiming to achieve full employment and price stability, rather than focusing solely on balancing the budget.

Question 7

Crowding out would most likely occur when:

Accepted Answer

Crowding out occurs when government spending increases, leading to higher demand for borrowing. This increase in borrowing raises interest rates, which can then limit or "crowd out" private investment. The federal government selling bonds to finance its budget deficit is a direct example of this process, as it requires borrowing that can lead to higher interest rates.

Question 8

Refer to the graph shown. Suppose the government borrows $50 million to finance an increase in its spending and that as a result, the level of investment is reduced by $50 million. In this case, the aggregate demand curve will:

Accepted Answer

The answer of Refer to the graph shown. Suppose the...

Question 9

An economist who follows a functional finance principle believes that the government should:

Accepted Answer

Functional finance is a principle that suggests the government should use its budgetary policy to achieve economic goals such as full employment and price stability, running deficits or surpluses as necessary depending on the state of the economy.

Question 10

When the economy is experiencing inflation, an economist who follows the functional finance theorem is most likely to suggest that the government should:

Accepted Answer

The functional finance theorem suggests that when the economy is experiencing inflation, the government should run a surplus. This approach aims to reduce the amount of money circulating in the economy, thereby helping to control inflation.

Question 11

If a government finances an increase in its expenditures by selling bonds to the public, then the aggregate demand curve will:

Accepted Answer

When a government finances increased expenditures by selling bonds to the public, it raises interest rates, which can crowd out private investment. This means the aggregate demand curve shifts out, but not as much as it would if crowding out did not occur, because some of the increase in demand from government spending is offset by a decrease in private spending.

Question 12

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

Foreign investors were willing to purchase U.S. government debt, providing an ample supply of savings that helped keep interest rates from rising despite large budget deficits.

Question 13

Reducing the budget deficit by cutting government spending could conceivably:

Accepted Answer

Reducing the budget deficit by cutting government spending can increase income if the resulting lower interest rates stimulate private investment, which is more productive than the government spending that was cut.

Question 14

Between 1999 and 2009, the U.S. federal budget deficit moved from a record surplus to a record deficit. Other things being equal, the most likely effect of this shift would be:

Accepted Answer

When the government runs a deficit, it borrows more, increasing the demand for loanable funds. This typically leads to higher interest rates, which can crowd out private investment by making borrowing more expensive for businesses and consumers.

Question 15

Which of the following is most representative of the functional finance view of the macroeconomy?

Accepted Answer

The functional finance view holds that government should use fiscal policy (tax and spending decisions) to achieve economic goals such as full employment and price stability, rather than focusing on balancing budgets or avoiding deficit spending.

Question 16

Fiscal policy would be more effective if:

Accepted Answer

Fiscal policy involves government spending and taxation. Its effectiveness is enhanced when the government can quickly adjust these levers in response to economic conditions, allowing for more responsive and timely interventions.

Question 17

Crowding out is associated with:

Accepted Answer

Crowding out occurs when increased government borrowing leads to higher interest rates, which in turn reduces business investment because borrowing costs become more expensive.

Question 18

Fine tuning the economy with fiscal policy is:

Accepted Answer

Fine-tuning the economy with fiscal policy is difficult because the government often lacks timely and complete information about the economy's current state and immediate direction. This information gap can lead to delays or inaccuracies in policy adjustments, making precise management challenging.

Question 19

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

The political processes of democracy often involve lengthy debates and negotiations, making it difficult to implement fiscal policy in a timely manner to address economic fluctuations effectively.

Question 20

Using fiscal policy to stabilize the economy is difficult because:

Accepted Answer

Fiscal policy involves government spending and taxation decisions, which are subject to time lags in their implementation and effects. These lags make it challenging to stabilize the economy promptly and effectively.

Quiz 32: The Fiscal Policy Dilemma