Question 1

Which of the following is true of debt financing?
A) Elected political officials will find debt financing attractive because it allows them to provide voters with visible current benefits while pushing the more visible costs into the future.
B) Debt financing is unattractive to elected political officials because voters recognize that excessive debt will lead to the future collapse of the economy.
C) Debt financing is attractive to elected political officials because countries with a higher debt to GDP ratio generally grow more rapidly.
D) Elected political officials will be reluctant to run budget deficits  because they recognize that taxes will have to be raised in the future to pay the interest on the larger amount of outstanding debt.

Accepted Answer

Debt financing is attractive to elected political officials because it allows them to provide immediate benefits to their constituents without raising taxes. This is because the costs associated with the debt (interest payments) are often spread out over time, making them less visible to voters. Option B is incorrect because excessive debt can lead to economic collapse, but this does not mean that elected officials will not find debt financing attractive in the short term. Option C is also incorrect - while it is true that some highly-indebted countries have grown rapidly, a high debt to GDP ratio is generally seen as a negative indicator of economic health. Option D is also incorrect because elected officials may still choose to run budget deficits despite the prospect of future tax increases.

Question 2

Which of the following is true of government debt?
A) The interest payments on federal bonds held by Americans will be paid to investors in other countries.
B) The share of the federal debt held by foreigners has declined from 34 percent of GDP in 1990 to less than 10 percent of GDP in 2015.
C) Between 2000 and 2015, federal debt owed to foreigners has risen from approximately 10 percent to 34 percent of GDP.
D) Less than 5 percent of the federal debt is owed to foreigners.

Accepted Answer

Between 2000 and 2015, the share of federal debt owed to foreigners increased significantly, reaching approximately 34 percent of GDP.

Question 3

The fiscal policy response to the recession of 2008-2009 was
A) a substantial increase in the budget deficit just as Keynesian analysis would recommend.
B) a balanced budget, just as Keynesian analysis would recommend.
C) a substantial increase in the budget deficit, which was highly inconsistent with Keynesian analysis.
D) a shift of the federal budget toward a large surplus, which  reflected the views of the critics of Keynesian economics.

Accepted Answer

The fiscal policy response to the 2008-2009 recession involved a substantial increase in the budget deficit, consistent with Keynesian economics, which advocates for increased government spending to stimulate demand during economic downturns.

Question 4

Which of the following helped transform the budget deficits of the early 1990s into surpluses later in the decade?
A) Rapid growth in the number of persons moving into the retirement phase of life during the 1990s
B) A reduction in defense expenditures following the end of the Cold War
C) A 1997 increase in the tax rate imposed on income derived from capital gains
D) A reduction in Social Security and health-care benefits during the 1990s

Accepted Answer

The reduction in defense expenditures following the end of the Cold War is the most significant factor in transforming the budget deficits of the early 1990s into surpluses later in the decade. It helped in lowering government spending and cutting the deficit. Other options such as increasing the tax rate on income derived from capital gains or reducing Social Security and health-care benefits may have helped, but it is not as significant as the reduction in defense expenditures. The retirement phase of life may have affected the economy but would not necessarily impact the budget deficits.

Question 5

The most effective fiscal stimulus will
A) create jobs, even if the employment is on unproductive projects.
B) substantially change the composition of aggregate demand.
C) encourage interest groups to lobby more intensely and make larger political contributions.
D) direct the economy to full employment and direct resources toward economically productive projects.

Accepted Answer

The most effective fiscal stimulus would direct the economy towards full employment and focus on economically productive projects, which would lead to sustained economic growth in the long run. Creating jobs on unproductive projects (choice A) would not contribute to the economy's growth or development, and choice B and C are not valid options. Therefore, choice D is the best option.

Question 6

Measured as a share of GDP, federal spending during 2001-2010
A) increased more rapidly than during the 1990s.
B) increased less rapidly than  during the 1990s.
C) declined after increasing rapidly during the 1990s.
D) was virtually unchanged during the decade.

Accepted Answer

Federal spending as a share of GDP increased more rapidly during 2001-2010 due to factors such as the wars in Iraq and Afghanistan, increased defense spending, and responses to the financial crisis, compared to the relatively stable or declining trend during the 1990s.

Question 7

Which of the following makes it more likely that a country will get caught in a vicious circle of debt financing, higher taxes, and sluggish growth?
A) Politicians like to raise taxes, but they are reluctant to spend on education, health care, and roads.
B) High levels of debt will eventually lead to higher taxes just  to pay the interest on the debt, but high taxes will slow economic growth.
C) As outstanding debt increases, politicians will be reluctant to run budget deficits, which will cause the economy to slow.
D) As outstanding debt increases, short-sighted politicians will want to run large budget surpluses in order to pay off the national debt quickly.

Accepted Answer

When a country has high levels of debt, it will eventually be pressured to raise taxes just to pay interest on the debt. However, high taxes can slow down economic growth by reducing disposable income and increasing the costs of production. This can cause a vicious cycle where sluggish growth leads to lower tax revenue, which then leads to higher debt, and the cycle repeats. Therefore, option B makes it more likely that a country will get caught in a vicious circle of debt financing, higher taxes, and sluggish growth.

Question 8

Suppose that increases in government expenditures and large budget deficits are projected for the next decade.  If strong growth is observed during this decade, this would be most consistent with
A) the Keynesian view.
B) the supply-side view.
C) the crowding-out effect.
D) the new classical theory.

Accepted Answer

The Keynesian view suggests that increased government spending can stimulate economic growth, especially during periods of underutilized resources.

Question 9

Compared to a reduction in tax rates, a one-time tax rebate will exert
A) a weaker impact on aggregate demand because the increase in the incentive to earn and impact on long-term income will be smaller for the temporary tax cut.
B) a stronger impact on aggregate demand because both the increase in the incentive to earn and impact on long-term income will be larger for the temporary tax cut.
C) an identical impact on aggregate demand because the size of the budget deficit will be the same regardless of whether the tax cut is temporary or permanent.
D) an identical impact on  aggregate demand because the incentive effects of a tax cut will be the same regardless of whether it is temporary or permanent.

Accepted Answer

A reduction in tax rates provides a permanent increase in the incentive to earn and impacts long-term income, whereas a one-time tax rebate only provides a temporary increase in the incentive to earn and impacts short-term income. Therefore, a reduction in tax rates would have a stronger impact on aggregate demand compared to a one-time tax rebate.

Question 10

Compared to a permanent reduction in tax rates, a temporary tax cut will generally
A) exert a larger impact on output and employment because its effects are immediate, long-lasting, and do not add much to the national debt.
B) exert a smaller impact on output and employment because the temporary cut will not exert much impact on long-term income or the incentive to earn.
C) exert a larger impact on output and employment because the temporary tax cut will lead to a larger budget deficit.
D) exert an identical impact on output and employment because the incentive effects will be the same regardless of whether the tax cut is temporary or permanent.

Accepted Answer

A temporary tax cut may provide a boost to the economy in the short term, but it is unlikely to have a significant impact on long-term economic growth or the incentive to work and invest. This is because taxpayers know that the temporary tax cut will expire and thus they will have to begin paying higher taxes again at some point in the future. As a result, they are unlikely to change their long-term behavior in response to the tax cut. In contrast, a permanent reduction in tax rates provides an ongoing incentive to work, invest, and save, which can lead to sustained economic growth over time.

Question 11

Which of the following most clearly indicates that fiscal policy is becoming more restrictive?
A) An increase in the budget deficit relative to GDP
B) A reduction in the budget deficit relative to GDP
C) An increase in government expenditures as a share of GDP
D) A reduction in tax revenues as a share of GDP

Accepted Answer

A reduction in the budget deficit relative to GDP indicates that fiscal policy is becoming more restrictive, as it means that the government is spending less and/or collecting more revenue. Option A would indicate the opposite, while options C and D do not necessarily reflect a change in the overall restrictiveness of fiscal policy.

Question 12

Which of the following will make it more difficult for the United States to control the growth of the federal debt in the decade ahead?
A) Debt financing makes it possible for elected political officials to provide voters with highly visible current benefits without having to impose visible current cost in the form of higher taxes.
B) The movement of the large baby-boom generation into the retirement phase of life will make it more difficult to control federal spending.
C) The recent growth of the federal debt as a share of GDP will tend to increase interest costs in the future.
D) All of the above.

Accepted Answer

All of the options listed will make it more difficult for the United States to control the growth of the federal debt in the decade ahead. Debt financing allows politicians to provide benefits without raising taxes, which can increase the debt. The retirement of the baby-boom generation will increase federal spending on programs such as Social Security and Medicare, also contributing to debt growth. Finally, as the debt-to-GDP ratio increases, interest costs will also rise, further exacerbating the debt problem.

Question 13

According to the Keynesian view, government spending will have its greatest impact during a severe recession because
A) automatic stabilizers will shift the budget toward a surplus during a severe recession.
B) underemployed resources will be widespread and the crowding out of private spending will be minimal.
C) budget deficits will reduce interest rates and thereby stimulate private investment.
D) increases in the government's outstanding debt will lead to lower future taxes.

Accepted Answer

Keynesian theory asserts that during a severe recession, unemployment and underutilization of resources are widespread, leading to a situation of deficient demand. In such a situation, government spending is believed to be most effective as it can directly boost aggregate demand without significantly crowding out private spending. Additionally, during a recession, interest rates tend to be low and monetary policy may be constrained, making fiscal policy an effective way to stimulate economic activity.

Question 14

Measured as a share of GDP, the borrowing of the federal  government from foreigners
A) is zero; the federal government does not borrow from foreigners.
B) is 100 percent; the federal government borrows only from foreigners.
C) has been approximately 50 percent of GDP since the early 1990s.
D) was approximately 10 percent of GDP in 2000, but it soared to 34 percent of GDP in 2015.

Accepted Answer

Measured as a share of GDP, the borrowing of the federal government from foreigners was approximately 10 percent of GDP in 2000, but it soared to 34 percent of GDP in 2015.

Question 15

Public choice analysis indicates that elected political officials will find debt financing
A) unattractive because voters will recognize that excessive debt will lead to the future collapse of the economy.
B) attractive because countries with a higher debt to GDP ratio generally grow more rapidly.
C) unattractive because both politicians and voters will recognize that a larger outstanding debt will mean higher future taxes.
D) attractive because current spending can provide voters with highly visible goods, services, and transfer payments, while borrowing will push the most visible cost of this spending into the future.

Accepted Answer

Public choice analysis suggests that elected officials are incentivized to pursue policies that provide immediate benefits to their constituents, such as visible goods and services, in order to secure votes and reelection. Debt financing allows politicians to provide these benefits without raising taxes in the short term, thus making it an attractive option. The costs of this spending are pushed into the future, which may not be as politically salient. Therefore, option D is the best choice.

Question 16

According to the Keynesian view, the large budget deficits of 2008-2015 resulted in
A) an increase in aggregate supply during that period.
B) weak aggregate demand and a continuation of recessionary conditions.
C) an increase in aggregate demand and higher real output during that period.
D) higher interest rates and taxes that slowed economic growth.

Accepted Answer

According to Keynesian theory, government spending can stimulate demand and increase output during a recession. Therefore, the large budget deficits during the period of 2008-2015 would have led to an increase in aggregate demand and higher real output, rather than weak demand and recessionary conditions.

Question 17

Measured as a share of GDP, the net federal debt
A) increased during the 1990s, but fell sharply during 2001-2011.
B) fell during most of the 1990s, but rose sharply during 2001-2011.
C) was virtually unchanged during the 1990s, but fell sharply during 2001-2011.
D) fell during the 1990s, but was virtually unchanged during 2001-2011.

Accepted Answer

The net federal debt fell during most of the 1990s, reaching its lowest point in 2001. However, it rose sharply during the period of 2001-2011, largely due to the wars in Iraq and Afghanistan, and the financial crisis of 2008.

Question 18

The paradox of excessive consumption argues that when households spend all they earn,
A) actual output and potential output will be in equilibrium.
B) the financial anxiety of families will be low.
C) the economy will achieve rapid, sustainable growth.
D) consumption can stagnate because families are in a poor position to deal with increases in debt and financial setbacks.

Accepted Answer

When households spend all they earn, they are in a poor position to deal with increases in debt and financial setbacks. This can lead to consumption stagnation and potentially harm the economy. Therefore, the paradox of excessive consumption highlights the need for households to save and invest, rather than solely focus on consumption.

Question 19

Which of the following most clearly indicates that fiscal policy is becoming more expansionary?
A) An increase in the budget deficit relative to GDP
B) A reduction in the budget deficit relative to GDP
C) An increase in the budget surplus relative to GDP
D) An increase in the nominal (dollar) size of the budget deficit

Accepted Answer

Fiscal policy becomes more expansionary when there is an increase in the budget deficit relative to GDP. This means that the government is spending more than it is taking in, which can stimulate economic growth by increasing demand for goods and services. A reduction in the budget deficit (choice B) or an increase in the budget surplus (choice C) would indicate more contractionary fiscal policy, as the government is either spending less or collecting more revenue. The nominal size of the budget deficit (choice D) does not provide information about whether fiscal policy is becoming more expansionary or contractionary, as it only relates to the actual dollar amount of the deficit, not its relative size to the overall economy.

Question 20

Measured as a share of GDP, the total federal debt
A) increased during the 1990s, but it has declined substantially during the most recent decade.
B) increased substantially during the recession of 2008-2009, but it is still well below the levels of the 1960s and 1970s.
C) has steadily trended downward during both the 1990s and the most recent decade.
D) is now approximately 100 percent of GDP, which is higher than at any time since the years immediately following World War II.

Accepted Answer

The total federal debt is now approximately 100 percent of GDP, which is higher than at any time since the years immediately following World War II. It has not steadily trended downward during either the 1990s or the most recent decade, and it has not declined substantially during the most recent decade. While it did increase substantially during the recession of 2008-2009, it is still well above the levels of the 1960s and 1970s.

Quiz 12: Fiscal Policy: Incentives, and Secondary Effects

Which of the following is true of debt financing?

Which of the following is true of government debt?

The fiscal policy response to the recession of 2008-2009 was

Which of the following helped transform the budget deficits of the early 1990s into surpluses later in the decade?

The most effective fiscal stimulus will

Measured as a share of GDP, federal spending during 2001-2010

Which of the following makes it more likely that a country will get caught in a vicious circle of debt financing, higher taxes, and sluggish growth?

Suppose that increases in government expenditures and large budget deficits are projected for the next decade. If strong growth is observed during this decade, this would be most consistent with

Compared to a reduction in tax rates, a one-time tax rebate will exert

Compared to a permanent reduction in tax rates, a temporary tax cut will generally

Which of the following most clearly indicates that fiscal policy is becoming more restrictive?

Which of the following will make it more difficult for the United States to control the growth of the federal debt in the decade ahead?

According to the Keynesian view, government spending will have its greatest impact during a severe recession because

Measured as a share of GDP, the borrowing of the federal government from foreigners

Public choice analysis indicates that elected political officials will find debt financing

According to the Keynesian view, the large budget deficits of 2008-2015 resulted in

Measured as a share of GDP, the net federal debt

The paradox of excessive consumption argues that when households spend all they earn,

Which of the following most clearly indicates that fiscal policy is becoming more expansionary?

Measured as a share of GDP, the total federal debt