Chapter 16: Fiscal Policy

Front 1

Define: Fiscal Policy. What are the characteristics of it? I.e. what is it and what is it not?

Back 1

Changes in government spending and taxes to achieve macroeconomic goals.

Actions taken by the government and intended to achieve macroeconomic goals

Front 2

Define: automatic stabilizers. What is its difference to discretionary fiscal policy?

Back 2

Automatic changes in government spending and taxes that go along with the business cycle.

In discretionary fiscal policies, the government takes actions.

Front 3

What is the difference between federal government spending and expenditures?

Back 3

Federal spending is a subset of expenditures which also include purchases without the transfer of goods such as transfer payments.

Front 4

What are the four categories of federal government expenditures?

Back 4

1. Purchases

2. Interest on National Debt

3. Grants to State and and Local Governments

4. Transfer Payments

Front 5

What are the two types of fiscal policies? What are their main goals?

Back 5

Expansionary and contractionary; changing government spending and taxes to shift the aggregate demand to fulfill the macroeconomic objectives.

Front 6

Why is the government purchase multiplier generally greater than the tax multiplier?

Back 6

Government purchases will directly have an effect on aggregate expenditures, while increases in disposable income will only have the indirect effect.

Front 7

What is the effect of cutting tax rates on multiplier effect? Why?

Back 7

It will increase the multiplier effect as it will increase disposable income.

Front 8

Why won't real GDP increase by what the multiplier effect indicates?

Back 8

Price level increases as a result of increasing aggregate demand. This reduces the quantity of goods and services demanded to fall.

Front 9

Why are fiscal policies harder to time than monetary policies?

Back 9

Bureaucracy: the legislative process can be longer, whereas monetary policies need only the decision of the central bank (Fed).

Front 10

What are the limits in implementing fiscal policies?

Back 10

1. Timing (recession may have ended before stimulation takes into effect)

2. Crowding out

Front 11

Define: crowding out. How does it link to fiscal policy?

Back 11

The process of increasing government spending which will cause a decline in private expenditures.

It is a problem because real GDP may fall as a result of increasing government spending.

Front 12

Crowding out: what is the process by which aggregate demand falls?

Back 12

Increases in government spending increases both income and spending. This increases the demand for currencies, causing a rise in interest rates.

Higher interest rates will cause private expenditures to fall.

Front 13

Crowding out: what occurs in the short run and long run?

Back 13

Short-run: interest rates rise from increasing spending. This causes an impartial offset of real GDP rise.

Long-run: government spending completely offsets increases in real GDP.

Front 14

Can tax rebates be an effective expansionary fiscal policy?

Back 14

It may not necessarily be effective because tax rebates does not change permanent income, which consumers base spending on.

Front 15

What is the primary reason why economists find it difficult to estimate the effects of fiscal policy?

Back 15

Differences in the believed size of the multiplier effect.

Front 16

What are the reasons why budget deficits occur automatically?

Back 16

Recessions decrease incomes which decreased government tax revenue and increase transfer payments such as unemployment programs.

Front 17

Define: cyclically adjusted budget deficit or surplus.

Back 17

A measurement of budget deficit if real GDP were at potential GDP.

Front 18

How can budget deficits serve as an automatic stabilizer?

Back 18

A recession decreases money households and firms owe the government (i.e. 'automatic tax cut') and increase transfer payments. Both will aid in retaining spending.

This will prevent the recession or inflation from worsening.

Front 19

What is the relationship between real GDP and the federal government budget?

Back 19

They are proportional: as real GDP increases, taxes increase, which will automatically balance the budget.

Front 20

Should the government always attempt to balance the budget instead of waiting for automatic stabilizers? Why or why not?

Back 20

In recessions (budget deficit), the government can only either increase taxes or decrease spending to balance it out. As such, it may worsen the recession.

During expansions, this may cause unintended inflation.

Front 21

Define: national debt. At what time does this increase? Why?

Back 21

The value of all treasury securities outstanding. This increases during budget deficits because the government borrows from investors to finance expenditures.

Front 22

Define: supply-side economics

Back 22

Fiscal policies which attempt to increase the economic capacity and growth in the long-term.

Front 23

Define: tax wedge. What are the supply side effects of tax reduction and simplification?

Back 23

The difference between pre-tax and after-tax returns on an economic activity.

The smaller the tax wedge, the larger the incentive to participate in economic activities such as working, saving, investing and start ventures; thus increasing productivity.

Front 24

What is the net effect of tax reductions simplifications, given that they are effective?

Back 24

They will increase working, saving investing and the formation of new firms, which increases long-run aggregate supply.

As such, both output and employment will increase and offset inflation as well.

Front 25

Formula: tax multiplier.

Back 25

(-1)*(MPC / 1 - MPC) * Change in T.