Question 1

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

Accepted Answer

Inflation-indexed government bonds do not eliminate inflation; they are designed to protect investors from the effects of inflation by adjusting the value of the bond payments based on inflation rates.

Question 2

The real value of government debt is reduced by:

Accepted Answer

Unexpected inflation reduces the real value of government debt because the nominal amount of the debt remains the same, but its real value is decreased by the increase in the price level. In contrast, expected inflation would be factored into the interest rate on the debt, so it would not result in a reduction of the real value of the debt. Deflation, whether expected or unexpected, would increase the real value of government debt.

Question 3

Using fiscal policy, including automatic stabilizers, to stabilize output over a business cycle is not consistent with:

Accepted Answer

A strict balanced-budget rule would require fiscal policy to remain neutral and not be used to stabilize output over a business cycle. This is because a strict balanced-budget rule requires that government spending and revenue be equal at all times, regardless of economic conditions. This would prevent the use of discretionary fiscal policy, including automatic stabilizers, to influence the economy. The other options (rational expectations, inflation targeting, and the natural-rate hypothesis) are compatible with using fiscal policy to stabilize output.

Question 4

One way to shift the tax burden from the current generation to future generations is to finance a war:

Accepted Answer

Running a budget deficit means that the government is spending more money than it is taking in through taxes. This can be used to finance a war without raising current taxes, shifting the burden of paying the expenses to future generations who will have to pay off the accumulated debt. Printing money may also be used to finance a war, but this can lead to inflation and other economic problems. Running a budget surplus would actually reduce the amount of debt that future generations would have to pay off, so it would not shift the tax burden to them.

Question 5

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

Accepted Answer

The answer of To minimize the disincentives of very high...

Question 6

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.

Accepted Answer

When investors fear a government default on debt, they are more likely to withdraw capital from that country, leading to capital outflows. This can cause the country's exchange rate to depreciate as there is less demand for its currency.

Question 7

Indexed bonds produce all of the following benefits except:

Accepted Answer

Indexed bonds are designed to protect investors from inflation risk by adjusting the principal and interest payments based on inflation rates, promoting financial innovation, and potentially influencing government fiscal policy. However, they do not directly result in lower rates of inflation; inflation rates are influenced by broader economic policies and conditions.

Question 8

Tax smoothing is a desirable policy because it:

Accepted Answer

Tax smoothing is a policy that aims to keep taxes relatively stable over time, regardless of changes in government spending or economic conditions. This helps to reduce the distortions of incentives caused by taxes and provides greater certainty for taxpayers and investors. Tax smoothing can also help to reduce the impact of automatic stabilizers, such as changes in government revenue that occur during periods of recession or expansion. However, tax smoothing does not necessarily require a balanced budget, as long as the government is able to service its debt over time.

Question 9

To force politicians to judge whether government spending is worth the costs, some economists have argued for:

Accepted Answer

A balanced-budget rule for fiscal policy would force politicians to consider the costs and benefits of government spending carefully since they would need to ensure that spending does not exceed revenue. This would enhance accountability and encourage more responsible use of public funds. By contrast, the other options do not directly address the need for politicians to consider the costs of government spending.

Question 10

One reason for not requiring a balanced federal budget at all times is that with a balanced-budget rule:

Accepted Answer

In a recession, the government needs to increase its spending to stimulate the economy. If a balanced-budget rule was in place, the government would not be able to do so, and the economy would suffer even more. The automatic stabilizing powers of our system of taxes and transfers would not be able to work effectively in this situation. Therefore, not requiring a balanced federal budget at all times can be helpful in such scenarios.

Question 11

In the United States, having a balanced budget is currently enforced for:

Accepted Answer

Many state governments in the United States are required by their own laws to have a balanced budget, but this requirement does not apply to the federal government.

Question 12

The possibility of capital flight is likely to be greater at higher levels of government debt because there is a greater:

Accepted Answer

When a government has a high level of debt, there is a greater temptation to default on the debt. This can lead to investors pulling their capital out of the country in fear of not being repaid, which is known as capital flight. Therefore, the possibility of capital flight is likely to be greater at higher levels of government debt because of the temptation to default on the debt.

Question 13

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:

Accepted Answer

Given the life-cycle consumption pattern and altruistic links between generations, a one-time temporary tax on the young with proceeds given to the elderly would lead to internal transfers within families. The young would reduce their consumption or savings to pay the tax, while the elderly would increase their consumption by the amount received. However, due to the altruistic links, the elderly might transfer back some or all of the proceeds to their young, aiming to smooth consumption across generations. Thus, the net effect on overall consumption would be neutral, as any decrease in consumption by the young would be offset by an increase in consumption by the elderly.

Question 14

Financing a budget deficit by ______ leads to inflation, and inflation ______ the real value of government debt.

Accepted Answer

Printing money to finance a budget deficit increases the money supply, leading to inflation. Inflation decreases the real value of government debt because the debt is repaid with money that is worth less in real terms.

Question 15

Hyperinflations typically occur when governments:

Accepted Answer

Hyperinflations occur when governments finance spending with the inflation tax, which involves printing money to pay for expenditures. This leads to an increase in the money supply and a decrease in the value of the currency, causing prices to skyrocket. This is different from setting high inflation targets or using discretionary monetary policy to stabilize output, which may have unintended consequences but will not necessarily lead to hyperinflation. Keeping unemployment below the natural rate may also contribute to inflation, but it is not the primary cause of hyperinflation.

Question 16

A strict balanced-budget rule would:

Accepted Answer

A strict balanced-budget rule would restrain political incompetence and opportunism by requiring the government to balance its budget, thus limiting the ability to engage in excessive spending or borrowing.

Question 17

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:

Accepted Answer

The answer of If the government levies a one-time temporary...

Question 18

Monetary policy is linked to fiscal policy when government spending is financed by:

Accepted Answer

When government spending is financed by printing money, it directly links monetary policy to fiscal policy, as it involves the central bank creating new money to fund government expenditures.

Question 19

The experience of the 1980s:

Accepted Answer

The experience of the 1980s may be used to argue both in favor of and against the Ricardian equivalence view of the tax cuts, depending on the interpretation and the perspective of the economist. On one hand, the low national saving during that period may contradict the Ricardian equivalence view that tax cuts would lead to an equal increase in saving and investment. On the other hand, the optimistic behavior of consumers and investors, as reflected in the stock market, may support the Ricardian equivalence view that people saved little only because they expected higher future income and wealth, which would allow them to pay back the additional debt incurred from the tax cuts. Therefore, the validity of Ricardian equivalence cannot be determined solely based on the experience of the 1980s, but needs to be evaluated in a broader context of economic theory, empirical evidence, and normative criteria.

Question 20

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

Accepted Answer

The expected rate of inflation can be estimated by subtracting the yield on index (inflation-protected) bonds from the yield on nominal bonds. This difference reflects the inflation premium included in the nominal bond yields.

Quiz 19: Government Debt and Budget Deficits