Question 1

Expansionary fiscal policy is enhanced by the multiplier effect,but compromised by the crowding out effect.

Accepted Answer

Expansionary fiscal policy, such as government spending or tax cuts, can stimulate aggregate demand and create a multiplier effect, where the initial increase in spending or tax cuts leads to an even greater increase in overall economic activity. However, this may also lead to higher interest rates, which can cause the crowding out effect where private investment decreases due to increased competition for loanable funds.

Question 2

Raising taxes to finance increases in government spending will only be an effective means of increasing aggregate demand if private savings rates are very low.

Accepted Answer

Raising taxes to finance increases in government spending may actually decrease aggregate demand, as people have less disposable income to spend. This is independent of private savings rates.

Question 3

Total Ricardian equivalence will render a tax cut ineffective in stimulating AD.

Accepted Answer

Total Ricardian equivalence suggests that individuals will anticipate future tax increases to compensate for current tax cuts, leading to no net increase in spending and therefore no effective stimulation of aggregate demand.

Question 4

Because of the multiplier effect,a smaller change in government spending is needed to generate a given change in aggregate demand.

Accepted Answer

The multiplier effect refers to the concept that a change in autonomous expenditure (such as government spending) leads to a larger overall increase in aggregate demand. This means that a smaller change in government spending can have a bigger impact on the economy, as the spending cycles through the economy and creates additional rounds of spending and income. Therefore, a smaller change in government spending is needed to generate a given change in aggregate demand, making option A true.

Question 5

Tax rebates are likely to have a larger impact on consumer spending if the tax cuts are permanent rather than temporary.

Accepted Answer

Permanent tax cuts provide consumers with more certainty about their future income, making it more likely that they will increase their spending in response to a tax rebate. In contrast, temporary tax cuts may lead consumers to save the rebate, as they may fear that their income will decrease once the tax cut expires.

Question 6

In 2008,the Bush administration issued tax rebate checks to taxpayers totaling $78 billion.The majority of households spent a larger percentage of these checks than they saved,thus leading to a big boost in overall growth in spending and output.

Accepted Answer

The majority of households saved or used the tax rebate checks to pay down debt rather than spending them, which limited the boost to overall growth in spending and output.

Question 7

When the government sells bonds to finance government expenditures,it actually encourages more household saving.

Accepted Answer

When the government sells bonds, it is essentially borrowing money from households and other investors. This means that households are investing their savings into government bonds. As a result, households are encouraged to save more in order to invest in government bonds, which can provide a secure and relatively low-risk investment option. Therefore, the sale of government bonds can encourage more household saving.

Question 8

In 2008,tax rebates were an effective means of fiscal policy since almost all of the money was spent immediately.

Accepted Answer

The effectiveness of the 2008 tax rebates as a means of fiscal policy is debated among economists. While some of the money was spent immediately, a significant portion was saved or used to pay off debt, not leading to the immediate economic stimulus that policymakers had hoped for.

Question 9

The crowding out effect refers to an increase in private spending that leads to a decrease in government spending.

Accepted Answer

The crowding out effect refers to a decrease in private spending that occurs when government spending increases. This happens because the increased government spending may lead to an increase in interest rates, which in turn makes borrowing more costly for individuals and businesses, causing them to reduce their spending.

Question 10

An investment tax credit provides an incentive for immediate investment spending.

Accepted Answer

An investment tax credit reduces the after-tax cost of new investment spending and encourages businesses to undertake investments they might have postponed. By making investment spending more attractive, it encourages businesses to increase output, create jobs, and expand their operations.

Question 11

The multiplier effect occurs when a change in government spending raises the incomes of people,who in turn increase their spending.

Accepted Answer

The multiplier effect is a real economic concept that suggests that an increase in government spending can lead to an even larger increase in economic output. This occurs because the initial increase in spending raises the incomes of people, who then use that additional income to increase their own spending. As a result, the effect "multiplies" as it passes through the economy, leading to greater overall economic growth.

Question 12

If Ricardian equivalence holds,fiscal policy has no effect on either inflation or real growth.

Accepted Answer

Ricardian equivalence suggests that individuals are forward-looking and will anticipate future taxes to finance government spending. Therefore, they will increase their savings to offset any temporary increase in disposable income from tax cuts or government spending. As a result, the overall impact of fiscal policy on aggregate demand, inflation and real growth is neutral.

Question 13

A tax rebate will be effective in stimulating aggregate demand if funds from the rebate are saved.

Accepted Answer

A tax rebate is intended to encourage spending and stimulate aggregate demand. If individuals save the funds instead of spending them, then there is no immediate impact on demand. However, if individuals use the rebate to pay off debt or invest, it may have a positive long-term effect on the economy.

Question 14

Fiscal policy is most effective when people are otherwise unwilling to spend money.

Accepted Answer

Fiscal policy involves government spending and taxation to influence the economy. When people are unwilling to spend money on their own, government spending can stimulate demand and provide a boost to the economy. This is why fiscal policy is most effective during times of economic downturn or recession, when consumer spending is low.

Question 15

If an economy is 2% below its long-run potential growth rate,the federal government can offset a recession with a 2% increase in discretionary spending.

Accepted Answer

While increasing discretionary spending may help stimulate the economy, it is not always a guarantee to offset a recession or bring the economy back to its long-run potential growth rate. The effectiveness of such spending depends on various factors such as the nature of the recession, the source of funding, and the overall economic conditions. Additionally, the appropriate response to a recession may vary and may involve a mix of monetary and fiscal policy actions.

Question 16

The crowding out effect reduces the effectiveness of fiscal policy in combating economic shocks.

Accepted Answer

The crowding out effect occurs when an increase in government spending leads to higher interest rates, decreasing private investment and consumption, and reducing the overall impact of fiscal policy. This reduces the effectiveness of fiscal policy in combating economic shocks.

Question 17

An effective way to combat real shocks is to change the growth in government spending.

Accepted Answer

Real shocks, which affect the supply side of the economy (such as changes in technology or resource availability), are not effectively addressed by changing government spending, which primarily influences the demand side. Monetary and fiscal policies are less effective against real shocks compared to supply-side policies like improving technology or labor market flexibility.

Question 18

Bond-financed expansionary fiscal policy is least likely to be effective when the private sector is reluctant to spend or invest.

Accepted Answer

The answer of Bond-financed expansionary fiscal policy is least likely...

Question 19

If consumers believe a tax rebate is permanent,they will spend more of it.

Accepted Answer

If consumers believe that a tax rebate is permanent, they are more likely to view it as an increase in their disposable income and therefore spend more of it. This is because they believe that they will continue to receive this extra income in the future, so they do not need to save as much of it. On the other hand, if consumers believe that the rebate is a one-time event, they may be more likely to save it or use it to pay off debt.

Question 20

The multiplier effect is the increase in AD when private spending augments the effect of expansionary fiscal policy.

Accepted Answer

The multiplier effect refers to the idea that an increase in government spending or investment will lead to an increase in overall economic output, as the initial spending stimulates further spending through a chain reaction. This is especially true when private spending also increases as a result of the policy, as it amplifies the overall impact on aggregate demand (AD). Therefore, statement "The multiplier effect is the increase in AD when private spending augments the effect of expansionary fiscal policy." is true.

Quiz 18: Fiscal Policy