Question 1

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 make timely fiscal policy difficult. Fiscal policy involves the government making decisions about spending and taxes, which can be subject to delays and disagreements within the political process. Additionally, there may be disagreements about the appropriate level of government involvement in the economy, which can further impede the use of fiscal policy.

Question 2

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 3

Crowding out would most likely occur when:

Accepted Answer

Crowding out occurs when the government borrows money to finance its spending, which can lead to higher interest rates and a decrease in private investment. Option B, where the federal government engages in bond sales to finance its budget deficit, is the only choice that directly relates to government borrowing and spending.

Question 4

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

Accepted Answer

When the government runs a deficit, it increases the demand for borrowing, which in turn increases the interest rate. This is because when there is more demand for borrowing, lenders charge a higher interest rate to lend money.

Question 5

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

Accepted Answer

A functional finance economist would suggest running a surplus to reduce inflation by decreasing aggregate demand.

Question 6

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

Accepted Answer

The functional finance view of the macroeconomy states that the government should make tax and spending decisions based on their potential effects on the economy. This means that deficits or surpluses should not be the primary goal, but rather the achievement of full employment and economic stability. This view emphasizes the active role of the government in managing the economy, in contrast to the idea that the economy is self-regulating without government intervention (A). It also does not prioritize balanced budgets for moral reasons (B), and does not assume that crowding out completely cancels out deficit spending (D). Therefore, option C is the most representative of the functional finance view of the macroeconomy.

Question 7

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 policy...

Question 8

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

Accepted Answer

According to the functional finance principle, the government's primary goal should be to maintain full employment and price stability. This means that if the economy is in a recession, the government should run a deficit to stimulate spending and create jobs. On the other hand, if the economy is overheating and inflation is a concern, the government should run a surplus to reduce spending and prevent inflation. Therefore, the government should run either a deficit or surplus depending on the state of the economy.

Question 9

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 government...

Question 10

Fine tuning the economy with fiscal policy is:

Accepted Answer

Fiscal policy involves changing government spending and taxation, which can have complex and far-reaching effects on the economy. The government may not have perfect information about the state of the economy or how its policies will impact it. Additionally, there may be lags between when policies are implemented and when their effects are felt, which can make it difficult to fine tune the economy in real time.

Question 11

Functional finance:

Accepted Answer

Functional finance is a theoretical proposition that focuses on the role of government fiscal policy in managing the economy, rather than being based on moral or ethical considerations.

Question 12

Reducing the budget deficit by cutting government spending could conceivably:

Accepted Answer

The answer of Reducing the budget deficit by cutting government...

Question 13

Refer to the graph shown.Expansionary fiscal policy shifts the aggregate demand curve from:

Accepted Answer

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

Question 14

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

Foreigners were willing to finance the U.S. deficit with their abundant supply of savings. This means that the government was able to borrow from foreign investors, which kept interest rates low and prevented crowding out.

Question 15

According to most economists, fiscal policy is:

Accepted Answer

Most economists believe that while fiscal policy can have some short-term impact on the economy, it is not an effective tool for fine tuning because of long policy lags and political constraints. Additionally, there may be unintended consequences such as inflation or crowding out of private investment.

Question 16

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 an increase in its expenditures by selling bonds to the public, it increases the demand for loanable funds, thereby raising the interest rate. Higher interest rates can lead to crowding out, which is a reduction in private investment due to government borrowing. This reduces the overall effectiveness of the increase in government spending. As a result, the aggregate demand curve will shift out, but not as much as it would if crowding out didn't occur.

Question 17

Using fiscal policy to stabilize the economy is difficult because:

Accepted Answer

Fiscal policy involves time lags due to the time it takes to recognize economic issues, implement policy changes, and for those changes to take effect in the economy.

Question 18

Fiscal policy would be more effective if:

Accepted Answer

Fiscal policy can only be effective if the government can quickly adjust taxes and government spending in response to changing economic conditions. Therefore, option B is the correct answer. Option A is not relevant to the effectiveness of fiscal policy. Option C is incorrect because the size of government debt matters greatly in terms of fiscal policy effectiveness. Lastly, option D is incorrect because crowding out (where government borrowing reduces private sector investment) reduces the effectiveness of fiscal policy.

Question 19

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 there is a budget deficit, the government has to borrow money to fund its spending, which increases demand for loans and drives up interest rates. Higher interest rates make borrowing more expensive for individuals and businesses, which tends to decrease investment. Therefore, the most likely effect of the shift from a surplus to a deficit would be higher interest rates and decreased investment.

Question 20

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 emphasizes that the government has a more active role in spending and taxing decisions in order to achieve macroeconomic goals such as full employment and economic growth. In contrast, sound finance focuses on balancing the budget and reducing government debt as the primary goals, which may require the government to have a less active role in spending and taxing decisions.

Quiz 32: The Fiscal Policy Dilemma