The merchandise trade balance
equals the value of tangible products exported minus the value of tangible products imported
Which of the following is not reflected on the current account balance?
net investment
When an American buys a Swedish financial asset,
the U.S. financial (or capital) account balance declines
Because of the accounting techniques used, the balance of payments shows that debits equal credits only if exports equal imports.
False
A net importer of assets must have a
financial (or capital) account surplus
Which of the following is a credit item (+) in the U.S. balance of payments?
U.S. companies sell merchandise abroad.
If the exchange rate changes from 75 cents per euro to $1 per euro, the euro
appreciated, since its value has increased
Which one of the following is not true?
The exchange rate is the price of a currency in terms of another currency for exchanges of goods and services but not for financial transactions.
The demand curve for euros shows
an inverse relation between the dollar price of a euro and the quantity of euros demanded
The demand for foreign currency in the United States
increases as the level of imports increases
If a foreign currency becomes more expensive in United States dollars, we would expect
U.S. exports to increase
Which of the following best describes a graph showing the supply and demand for foreign exchange?
The quantity of foreign exchange is on the horizontal axis and the price of foreign exchange in terms of the domestic currency is on the vertical axis.
Suppose that U.S. tastes for British goods increase. Then, in Exhibit 18-4
the demand curve shifts from D1 to D2
An increase in the U.S. demand for foreign exchange will cause a(n)
increase in the price of foreign exchange, which is a depreciation of the U.S. dollar, making foreign goods more expensive to U.S. residents
increase in the price of foreign exchange, which is a depreciation of the U.S. dollar, making foreign goods more expensive to U.S. residents
in Paris while buying them in New York
According to the purchasing power parity theory, in the long run
the exchange rate between the Canadian dollar and the British pound should reflect differences in price levels between Canada and Britain
Suppose a basket of goods that costs $400 in the United States costs only �200 in Britain and the current exchange rate is $1/pound. According to the purchasing power parity theory, the equilibrium exchange rate should be higher than $1/pound. Why?
The basket could be purchased in Britain for �200 and sold in the United States for $400, and the $400 could be used to purchase �400 for a �200 profit.
Imagine there are only two countries in the world, Mexico and Canada, and two currencies, pesos and Canadian dollars. If Mexico's central bank wants to protect its currency from depreciating in response to the demand shift shown in Exhibit 18-6, which of
purchasing pesos with reserves of Canadian dollars
The main goal of the Bretton Woods meeting was to
set up a new international system of payments and to stabilize exchange rates
The breakdown of the Bretton Woods system occurred because
the dollar was overvalued
The balance of goods and services is
the value of all goods and services exported minus the value of all goods and services imported
Given the hypothetical data in Exhibit 18-1, what is the balance on current account?
-$2,500
Which of the following would contribute, directly or indirectly, to a deficit in the financial (or capital) account of the U.S. balance of payments?
Interest rates fall in the United States relative to their level in the rest of the world.
When is a balance of payments account out of balance?
never
The statistical discrepancy
is a residual factor that indicates the net error in the balance of payments data
Which of the following would be represented as a debit in the U.S. balance of payments?
U.S. purchase of cars from Italy
rom the U.S. perspective, a drop in dollar price of foreign exchange means that
the U.S. dollar has appreciated
The exchange rate is the
price of one country's currency in terms of another country's currency
Which of the following is not assumed constant along the U.S. demand curve for foreign exchange?
The exchange rate
If the U.S. dollar appreciates relative to the Brazilian cruzeiro, then
the US will import more from Brazil
An increase in U.S. income that increases American demand for all normal goods (including imports from Britain) will shift
the U.S. demand curve for foreign exchange to the right, causing an increase in the dollar-per-pound exchange rate
Which of the following is represented by Exhibit 18-3?
An increase in the Canadian demand for Swiss francs.
Suppose that British incomes rise relative to incomes in the United States. Then, in Exhibit 18-4
the supply curve will shift from S1 to S2
A rightward shift of the Canadian demand curve for foreign exchange will
decrease the value of the Canadian dollar
Foreign exchange rates tend toward equality around the world because of the actions of
arbitrageurs
Suppose a basket of goods costs $400 in the United States and �200 in Britain. If the exchange rate is $1/pound, what will happen in the foreign exchange market, according to the purchasing power parity theory?
n increase in demand for pounds will lead to an increase in the price of pounds.
A floating exchange rate
adjusts in response to market forces
Under fixed exchange rates, a central bank
may find its foreign exchange reserves fluctuating as demand and supply conditions change
Under the gold standard, all except one of the following are true. Which is not true?
A surplus country experienced a rise in its money supply and a drop in its price level.
The Bretton Woods system
established a worldwide system of fixed exchange rates
Assume the United States and China produce only two goods, oil rigs and clothes. The maximum amounts that each country can produce of each good are given in the table below. The United States has a comparative advantage in producing: (OTHER SIDE)
A) oil r
B
Refer to Exhibit 5-2. If this graph represents the aggregate demand and supply model, how would you illustrate how the United States economy experienced both inflation and a dramatic decrease in the unemployment rate during the 1990s? (OTHER SIDE)
A) line
A
As A) purchase more domestically produced goods and fewer foreign goods, resulting in
a result of a quota on imports, consumers in the importing country
the consumption of more total goods than without the tariff B) purchase more domestically produced goo
B
According to economists, money serves as the following except
A) B) C) D)
a medium of exchange a store of value a unit of account capital
D
Suppose the Fed wants to keep the interest rate fixed, but notices a fall in the interest rate. Which of the following would be the likely cause of the interest rate decrease, and what would be the Fed's likely response? A) Cause: an increase in money dem
D
If a household's income falls from $47,700 to $46,700 and its consumption spending changes from $36,000 to $35,020, then its
A. marginal propensity to consume is 0.86
B. marginal propensity to consume is 0.98
C. marginal propensity to save is 0.01 margina
B
Pat, Martin, Charles, and Jared are comparing the starting salaries in their first jobs. The year each started his or her first job, the CPI in that year, and each person's nominal starting salary are given below.
Who negotiated the highest real starting
B
When the economy is at full employment, which unemployment may not exist? A) None
B) Structural and Frictional. C) Seasonal D) Frictional and Structural E) Cyclical
E
George was laid off from his job of pruning grapevines because he had an argument with his boss. The only other business in the town is a defense contractor. Business is booming for the defense contractor and George found a job there after being unemploye
D
Bank reserves can be held in the form of deposits with the Fed A) True B) False
A
Refer to the diagram above. A decrease in the market interest rate would cause
(A) an increase in the level of planned investment due to a movement along the investment demand curve. (B) a decrease in the level of planned investment due to a higher rate o
A
According to your textbook, through what channel does monetary policy influence the level of real GDP and the price level?
A) MONEY SUPPLY ? ? INTEREST RATE ? ? INVESTMENT ? ? AGGREGATE DEMAND ? ? REAL GDP ? AND PRICE LEVEL ?
B)MONEY SUPPLY ? ? INTEREST R
B
If fiscal policy is used to close a recessionary1 gap, the
A. SRAS curve shifts leftward and the price level falls
B. SRAS curve shifts rightward and the price level increases
C. SRAS curve shifts rightward and the price level falls
D. AD curve shifts lef
E
Suppose U.S. consumers start buying fewer English shoes and more U.S. shoes. What
impact will this trend have on the foreign exchange market? A) U.S. demand for foreign exchange, in general, and British pounds, in particular,
will increase. B) U.S. demand
B
In the short run, an increase in the federal budget surplus A) only occurs when there is a surplus in the balance of trade B) creates inflation C) decreases aggregate demand D) decreases aggregate quantity demanded along a stationary aggregate demand
curv
C
The Lee family won a $50 million jackpot and made several major purchases this year, listed below. Which of these would be counted as private domestic investment when calculating GDP by the expenditure approach? A) the former Hollywood home of Gwyneth Pal
C
In 2007, if the country of Moolah had consumption of $20 trillion, gross investment of $4 trillion, government purchases of $5 trillion, and GDP of $26 trillion, then exports must have been
A) + $3 trillion B) + $29 trillion C) - $29 trillion D) - $3 tril
E
Exhibit 32-2 shows the domestic demand and supply of corn in the United States. If the world price of corn is $2 and there are no trade restrictions, the United States will
A. produce 7,000, consume 3,000, and import 4,000 bushels of corn
B. produce 3,000
C
Refer to Exhibit 30-4. If policymakers want to use discretionary fiscal policy to eliminate
the output gap, which of the following actions would NOT be appropriate?
A. decrease wages
B. decrease transfer payments such as unemployment compensation
C. raise
A
The production possibility frontier below shows the different combinations of hot dogs and pizzas that could be produced by a hypothetical economy. When a foreign producer offers to sell 2 pizzas in exchange for 1 hot dog, how can the economy move its con
A
The table above shows the market value of items purchased in a hypothetical economy in a given year. All of the items were produced within the borders of the country in the current period. The motherboards were purchased by the computer company, where the
C
Refer to the three graphs above. An economy was devastated by a catastrophic earthquake followed by a nuclear meltdown crisis, and its ability to produce either the consumer goods or the capital goods is dampened. This is illustrated in
A. The inward shif
A
The problem of scarce resources
A) B) C) D)
means that in some cities there are not enough jobs could be solved if the unemployment rate fell is that there are not enough resources to satisfy people's unlimited wants is that resources are used inefficient
C
Monetary policy affects the equilibrium level of Real GDP and the equilibrium Price Level by shifting
A.Money Demand
B. Short Run Aggregate Supply
C. Long Run Aggregate Supply
D. Aggregate Demand
D
In determining comparative advantage, cost is measured in terms of
A.foreign currency
B. domestic currency
C. gold only
D. units of weight and measure
E. opportunities forgone
E
If a country has an absolute advantage in the production of every good, it cannot benefit from trade with other countries.
a. True b. False
B
One reason for international specialization in production is a. a high tariff imposed by a national government b. a low tariff imposed by a national government c. diminishing returns to a variable factor of production d. the different resource endowments
D
If the country illustrated in Exhibit 19-3 is initially trading without restrictions at a world price of $1.00, the loss of consumer surplus as a result of a tariff of $0.50 per unit is represented by area
a. a
b. b+d
c. c+i+e+f
d. c
e. d
C
Which of the following is true concerning the impact of tariffs and quotas? a. Tariffs raise the price of a good but quotas do not. b. Tariffs reduce consumer and producer surplus whereas quotas reduce domestic
consumer surplus and increase domestic produ
D
Which of the following is not a type of trade restriction? a. low-interest loans to foreign buyers b. export subsidies to domestic producers c. restrictive health and safety standards
d. domestic content requirements e. economies of scale
E
Which of the following is not a problem with trade restrictions? a. the high cost of rent-seeking activities such as lobbying b. the high cost of enforcement c. the unintended effects on related industries
d. the ability to save U.S. jobs in the short run
D
Because of the accounting techniques used, the balance of payments shows that debits equal credits only if exports equal imports.
a. True b. False
B
If the current account is in deficit, imports of goods and services exceed exports of goods and services (plus net unilateral transfers).
a. True b. False
A
When an American buys a Swedish financial asset, a. bothcandd b. the U.S. balance of goods and services worsens c. the U.S. financial account balance declines
d. the U.S. balance of payments worsens e. the U.S. trade balance worsens
C
Which of the following is a credit item (+) in the U.S. balance of payments? a. imports of cars from Japan b. any transaction that results in an inflow of dollars c. a US citizen sends money to his aunt in Uruguay
d. a U.S. firm's purchase of steel from a
B
If the exchange rate changes from 20 cents per franc to 18 cents per franc, the U.S. dollar has
a. appreciated, since its value has increased b. appreciated, since its value has declined c. depreciated, making French goods more expensive in U.S. dollars d
A
Suppose the Swiss government wants to set the exchange rate at A in Exhibit 18-3. The appropriate action for the government to take after the demand shift shown is
a. to reduce its demand for dollars from Canada b. to reduce its supply of francs to Canada
C
Industrial market countries are also referred to as a. developing countries b. low-income economies c. middle-income economies
d. transitional economies e. high-income economies
E
Which of the following groups has the lowest life expectancy at birth? a. middle-income economies b. low-income economies c. high-income economies
d. sub-Saharan African economies e. all the world's economies
D
Social capital is a. the shared values and trust that promote cooperation in the economy b. the buildings and equipment used to produce goods and services c. a government regulation aimed at improving health and safety d. the accumulated knowledge, skill,
A
The opportunity cost of holding money increases when
the interest rate rises
The money demand curve slopes
downward because the cost of holding money decreases as the interest rate decreases
The demand for money varies
positively with both the price level and the level of real GDP
As the price level rises, money __________ causing interest rates to __________ and investment spending to __________.
demand rises; rise; fall
If the money supply decreases, the opportunity cost of holding money __________ and people will want to hold __________ quantity of money.
rises; a smaller
Which one of the following statements is correct?
A vertical money supply curve means that the quantity of money supplied is independent of the interest rate.
An increase in the money supply will cause a decrease in planned investment spending.
False
If the Fed increases the money supply, then
the interest rate declines and the quantity of money demanded increases
If the Fed increases the money supply, GDP
increases because the resulting decrease in the interest rate leads to an increase in investment
If investment is not sensitive to changes in the interest rate, then changes in the money supply
will have little effect on aggregate demand
Which monetary policy would be appropriate to close a contractionary gap?
the Fed's purchase of U.S. government securities
When the short-run aggregate supply curve is steep, then for a given increase in aggregate demand,
the increase in real GDP will be relatively small and the increase in the price level will be relatively large
The equation of exchange states that
nominal GDP = money in circulation ' velocity
If the Fed expands the money supply, a short-run aggregate supply curve __________ would yield the largest short-run increase in real GDP.
that is relatively flat
In an economy in which velocity is constant and real output grows at an average rate of 3 percent per year, a 5 percent average rate of growth in the money supply would result in a
slowly increasing price level
The quantity theory of money states that
since velocity is reasonably stable, we can predict the effects of an increase in the money supply on nominal income
Which of the following would most likely lower the velocity of money?
a lower inflation rate
Historical evidence has shown that the M1 velocity of money in the United States
has varied over the century and has recently fluctuated a quite a bit
Suppose the money demand curve shifts rightward. Which of the following is true about the Fed's options?
The Fed can keep the interest rate from rising only if it increases the money supply.
Those who argue against interest rate targets for monetary policy claim that
the necessary changes in money supply reinforce business cycles
People will hold __________ money as the interest rate __________ because they will __________ other financial assets.
more; decreases; sell
Which of the following would cause a downward movement along the money demand curve?
a decrease in the interest rate
Which of the following is not assumed to be constant along the money demand curve?
the interest rate
When people exchange money for financial assets, the interest rate rises.
False
An increase in the money supply will
lead people to try to exchange money for interest-bearing assets
If the quantity of money supplied exceeds the quantity of money demanded,
the interest rate will fall
In the aggregate demand-aggregate supply model, a decrease in the money supply will cause a short-run
decrease in both the price level and real GDP
If the Fed sells U.S. government securities to drain reserves from banks, which of the following will probably occur?
The interest rate will rise and the quantity of money demanded will fall.
If the Fed sells government securities to banks, eventually we expect
planned investment expenditures to decrease
If interest rates are __________ to changes in the money supply and planned investment expenditures are __________ to interest rate changes, then monetary policy will be effective in changing aggregate demand.
responsive; sensitive
In the situation shown in Exhibit 15-1, how could the Fed return the economy to potential output?
Decrease money supply
The economy shown in Exhibit 15-3 is in equilibrium where AD=SRAS. To bring the economy to its potential output level, the Fed could
decrease the money supply and decrease the price level to P'
According to the equation of exchange, if nominal GDP equals $6 trillion and the money supply equals $1 trillion, the velocity of money
must be 6
In the long run, an increase in aggregate demand
affects only the price level
In an economy in which real output grows at an average rate of 3 percent per year, a 7 percent average rate of growth in the money supply would result in a(n)
inflation rate of 4 percent, if velocity were constant
The quantity theory of money
states that the quantity of money in circulation determines only the price level in the long run
Velocity will be higher
the less effective money is as a store of value
In the United States over the last decade, the velocity of
both 3) and 4) are true
If the Fed is targeting interest rates and money demand shifts from Dm to Dm' in Exhibit 15-4, the Fed will
increase the money supply to restore its target of i
In the history of monetary policy, the period of October 1979 to October 1982 was notable for
the emphasis placed on controlling the money supply during that period
Which of the following can commercial banks count as legal reserves?
Vault cash and deposits of the bank with the Fed.
Which of the following would be most appropriate if the Federal Reserve wanted to increase the money supply in order to stimulate the economy?
Buy U.S. securities
The immediate effect of a member bank's sale of U.S. government securities to the Fed is...
an increase in that bank's excess reserves.
Which of the following actions would the Fed undertake if it wants to follow a more restrictive monetary policy?
sell some of its holdings of government bonds.
Suppose that in a country people gain more confidence in the banking system and so hold relatively less currency and more deposits, then bank reserves will
increase and the money supply will eventually increase.
Which of the following will cause the U.S. money supply to expand?
A commercial bank uses excess reserves to extend a loan to a customer.
Which of the following is the primary tool the Fed uses to control the supply of money?
Open market operations
If people decide to hold less money as currency and more as checking deposits, this will most likely cause a(n)
increase in the money supply.
Other things constant, a reduction in the real interest rate will
induce businesses to increase their level of investment.
When an economy is in a recession
the unemployment rate will rise above its natural rate.
If an economy was initially in long-run equilibrium, an unanticipated increase in aggregate demand will tend to cause
a temporarily high level of output and employment that cannot be maintained.
When output is greater than the economy's long-run capacity, which of the following is most likely to occur?
increases in real interest rates and real resource prices
If an unanticipated reduction in aggregate demand throws a market economy into a recession,
lower real resource prices and interest rates will act as a stabilizing force and direct the economy back to its full employment potential.
Which of the following will most likely increase long-run aggregate supply?
an increase in the rate of investment.
If an economy operates at a short-run equilibrium output that exceeds its long-run capacity, which of the following will be most likely to direct the economy toward full employment?
Resource prices will increase, causing the SRAS curve to shift to the left.
When the economy is operating at an output beyond its full-employment potential, the
strong demand for resources will place upward pressure on resource prices.
Which of the following will most likely occur as the result of an unanticipated increase in aggregate demand that pushes output beuond long-run capacity?
an increase in the real interest rate.
Which of the following is a major deficiency of fiscal policy as a stabilization tool?
Both political and economic factors make it unlikely that changes in fiscal policy will be timed correctly.
According to the Keynesian view, which of the following would most likely stimulate real output if an economy were in a recession?
A decrease in tax rates
If the economy is experiencing inflationary boom, and the government lowers taxes in an effort to balance the budget, the Keyneseian model indicates that the likely effect will be to
continue inflationary pressures
Keynesian analysis stresses that a tax cut that increases the governments budget deficit (or reduces its budget surplus)
will stimulate aggregate demand and, therby, promote employment.
Crowding out refers to the situation in which
borrowing by the federal government raises interest rates and causes firms to invest less.
Raising taxes as an element of discretionary fiscal policy is intended to reduce aggregate demand, but it can also reduce aggregate supply if
the higher taxes cause workers to work less
Which of the following is a correct conclusion regarding the use of coutercyclical fiscal policy?
Successful fiscal policy is difficult to achieve because Congress acts slowly and our ability to predict the future is limited.
If policy makers believe that an inflationary boom is about to begin, the Keynesian view indicates that they should
decrease government spending and/or raise taxes.
Fiscal Policy
1) Focuses on the effects of taxing and public spending on aggregate economic activity
2) Refers to gov't purchases, transfer payments, taxes, and borrowing as they affect macroeconomic variables such as real GDP, employment, price level, and economic gro
Aggregate Demand
the total quantity of output demanded at alternative price levels in a given time period
When economists study fiscal policy, the usually focus on who?
The federal gov't, although gov'ts at all levels affect the economy
Automatic Stabilizers
1) Revenue and spending programs in the federal budget that automatically adjust with the ups and downs of the economy to stabilize disposable income, and consequently, consumption and real GDP
2) Structural features of gov't spending and taxation that re
Give an example of an automatic stabilizer and why.
Federal income tax
1) once adopted it requires no congressional action to operate year after year so it's automatic
2) reduces drop in disposable income during recessions and reduces jump in disposable income during expansions
Discretionary Fiscal Policy
1) Deliberate manipulation of gov't purchases, transfer payments, and taxes to promote macroeconomic goals like full employment, price stability, and economic growth
2) can be a one-time thing/temporary. Ex. Bush's 2008 one-time tax rebate
When is the gov't budget balanced?
When gov't purchases equal net taxes
Gov't purchases and net taxes are autonomous of what?
Income
For a given price level and assuming that only consumption varies with income, what is the formula for the simple spending multiplier?
1/(1-MPC)
Describe the effect of a decrease in net taxes
1) Increases in disposable income at each level of real GDP, so consumption increases
2) Graphically and numerically it is the shift of the aggregate expenditure line times the simple spending multiplier
(-MPC X change in net taxes) X (1/(1-MPC)) which re
Net Taxes
Government tax revenues minus transfer payments
At each round of spending and level of GDP, how much does consumption spending increase?
Increases by the decrease in net taxes X marginal propensity to consume
What could cause a decrease in net taxes?
1) tax cut
2) increase in transfer payments
Simple Tax Multiplier
1) Ratio of a change in real GDP demanded to the initial change in autonomous net taxes that brought it about; the numerical value of the simple tax multiplier is (-MPC/(1-MPC))
What are the 2 differences b/w gov't purchase multiplier and the simple tax multiplier
1) GPM- positive. STM- negative
2) GPM will always be (the absolute value of) >1 than the STM, b/c GPM affects aggregate spending directly while STM affects aggregate spending indirectly
Price Level
an index that traces the relative changes in the price of an individual good (or a market basket of goods) over time
Expansionary Fiscal Policy
Increase in gov't purchases, decrease in net taxes, or some combo of the 2 aimed at increasing aggregate demand enough to reduce unemployment and return the economy to its potential output; fiscal policy used to close a recessionary gap
Why are expansionary fiscal policies put in place?
Sometimes if the gov't believes that natural market forces are taking too long to adjust to unemployment that exceeds the natural rate (history suggests that wages and other resource prices could be slow to respond to a recessionary gap)
Describe the effect of excess quantity demanded
Causes the price level to rise, real GDP supplied to increase but real GDP demanded to decrease along new aggregate demand curve. Price level rises until Q demanded= Q supplied
Describe the intersection point when Q demanded and Q supplied are equal as a result of an expansionary fiscal policy
1) It represents both the short run and long run equilibrium. When this intersection point is achieved by an expansionary fiscal policy
2) closes the recessionary gap.
3) but increases output and therefore price level
3) If the federal budget was in balan
What happens if the federal gov't imposes an expansionary fiscal policy but stimulates aggregate demand more than enough to achieve potential GDP?
In the short run, real GDP exceeds potential output
In the long run, short-run aggregate supply curve shifts back until it intersects the aggregate demand curve at potential output, increasing the price level further but reducing real GDP to the potential
Contractionary Fiscal Policy
Decrease in gov't purchases, increase in net taxes, or some combo of the two aimed at reducing aggregate demand enough to return the economy to potential output w/out worsening inflation; fiscal policy used to close an expansionary gap. The gap would ordi
Why are discretionary and contractionary fiscal policies hard to achieve?
1) assumes potential output can be accurately gauged
2) relevant spending multiplier can be predicted accurately
3) aggregate demand can be shifted by right amount
4) various gov't entities can coordinate fiscal efforts
5) shape of SRAS is known and remai
In the short run what happens when there's a shift in aggregate demand? Why?
Both price level and output level changes b/c aggregate supply curve slopes upward
Finish this statement, the steeper the SRAS curve...
The less impact a given shift of the aggregate demand curve has on real GDP and the more impact it has on the price level, so the smaller the spending multiplier
If the economy is already producing its potential, the spending multiplier in the long run is?
0. B/c in the long fun, any change in fiscal policy aimed at stimulating demand increases the price level but doesn't affect output
Classical economists. Say everything you know about it and the time period.
1) Group of 18th and 19th century economists who believed that economic downturns corrected themselves through natural market forces; thus, they believed the economy was self-correcting and needed no gov't intervention
2) Laissez-faire
3) Before great dep
How did the Great Depression contrast with the classical economists' views?
1) depth/duration of depression strained belief in economy's ability to heal itself
2) 4 years of contraction, 25% unemployment, investments fell 80%, output and income fell well short of economy's potential
Discuss why Keynes was challenging the classical economists' view and what it was in response to.
1) Response to problem of high unemployment in the Great Depression
2) Prices and wages didn't seem to be flexible enough to ensure full employment of resources
3) believed business expectations might at times become so grim that even low interest rates w
Keynes believed prices were _____. What does that mean?
Stick. Relatively inflexible in the downward direction. Natural market forces wouldn't return economy to full employment in a timely fashion
What 3 events after the Great Depressions spurred the use of discretionary fiscal policy in the U.S.?
1) Keynes- natural forces wouldn't necessarily close a recessionary gap. Economy could get well below potential requiring gov't to increase aggregate demand to boost output and employment
2) WWII- greatly increase production and erased cyclical employment
What was the dominant fiscal policy before the Great Depression?
Balanced budget.
After the Great Depression and Keynes, what was the dominant fiscal policy?
Promote full employment with price stability even if budget deficits resulted
How do automatic stabilizers smooth out fluctuations in disposable income?
Business cycle: recessions- stimulating aggregate demand
Expansions: dampening aggregate demand
Explain how a progressive tax policy is an automatic stabilizer.
As someone increases in income during expansions, more of their income is taken b/c they move up tax brackets and vice versa.
What is another example of an automatic stabilizer besides federal income tax and welfare benefits? Explain.
Unemployment benefits.
1) Expansions- system automatically increases flow of unemployment insurance taxes from the income stream to the unemployment insurance fund
2) Contractions- unemployment increases. Unemployment payments flow from insurance fund to
Discuss the relationship between GDP, disposable income, and consumption with the effect of automatic stabilizers
1) Disposable income and consumption varies proportionally less than GDP
2) GDP fluctuates less than it otherwise would
What is the result of a greater influence of automatic stabilizers on the economy?
The economy is much more stable than it was during the Great Depression and before
Were unemployment benefits, welfare benefits, and the federal tax income made initially as automatic stabilizers? What were their initial intentions?
No. Redistribution of income.
Finish this statement: The stronger and more effective the automatic stabilizers____________________
The less need for discretionary fiscal policy
When was the Golden Age of discretionary fiscal policy?
1960s. Kennedy and LBJ
What discretionary fiscal policy did Kennedy first propose?
Proposing a federal budget deficit in order to close a recessionary gap
What discretionary fiscal policy did LBJ propose? What was the result of that policy?
1) Cut taxes to speed up an expansion already under way
2) Increased disposable income and therefore consumption. Unemployment rate dropped below 5%, inflation rate below 2%
Finish this statement and explain: discretionary fiscal policy is a _____________________ policy.
1) Demand management policy
2) Its objective is to increase or decrease aggregate demand to smooth economic fluctuations.
What is stagflation?
High unemployment and high inflation resulting from a decrease in aggregate supply (such as a crop-crisis)
Why is it difficult to apply discretionary fiscal policies during periods of stagflation (such as in the 1970s)?
Because in increase in aggregate demand would increase inflation and a decrease in aggregate demand would increase unemployment
Counterargument to Keynesian theory
Flexibility of prices and wages. The economy will self-adjust on its own.
What are the concerns about the effectiveness of discretionary fiscal policy?
1) difficulty estimating natural rate of employment
2) the time lags involved in implement fiscal policy
3) distinction b/w current and permanent income
4) possible feedback effects of fiscal policy on aggregate supply
What is the rate of natural unemployment?
The unemployment rate when the economy is producing its potential output
Political Business Cycles. Arguments for and against them.
1) Economic fluctuations that occur when discretionary policy is manipulated for political gain
2) Suggest expansionary monetary policies during election years
3) Against- Limits presidential motives to reelection, also the economy is not always the key i
Give a link that some argue that is between Democratically elected presidents and Republican elected presidents in terms of employment and inflation
1) Democrats more willing to pursue expansionary policies to decrease unemployment and increase inflation/deficits
2) Republicans more willing to pursue contractionary policies to control inflation, even though it may cause the country to go into a recess
Discuss the issue of time with fiscal policy
Takes too long to approve/implement, so by the time it is finally approved it may not longer be needed and may even be harmful
Permanent Income. Also discuss the effects of temporary tax changes.
Income that individuals expect to receive on average over the long term. There is little effect on consumption when a temporary tax change is implemented b/c consumers base their decisions on permanent income as well not just their current income
Discuss the feedback effects of fiscal policy on aggregate supply
This is usually unintentional. With unemployment benefits and tax hikes (on certain groups) it doesn't necessarily change the equilibrium GDP, but it can change the labor supply (reducing opportunity cost of not working, finding a job slower, working fewe
Explain how during Clinton's term the federal deficit was eliminated
After large budget deficits in the early 90's, growing consumer spending, rising business optimism based on technological innovation, market globalization, and the strongest stock market in history, higher taxes on the rich and more spending economy
Discuss who pays the most of the federal tax and how much.
Top 10% pay 2/3rds of it
Discuss the beginning of the 2007 recession and the actions of the Bush Administration to address that problem. Did it work?
1) Began quietly with declining home prices and rising foreclosure rates
2) $117 billion one-time tax rebate passed by Congress and Bush (so it added to the deficit)
3) It didn't work, the marginal propensity to consume from rebate money was less than 1/3
During the 2007 recession, what is the significance in the drop of real GDP during 2008?
It was >3% and someones even >6%. The largest drop since 1980
Describe the bailouts of the recent recession.
1) Bailout- gov't unfreezes financial flows by investing in financial institutions (ex. TARP) since credit markets froze around the world and refused to lend money for fear that the borrower might go bankrupt
2) Lehman Brother's (4th largest investment ba
American Recovery and Reinvestment Act
Obama legislation at $862 billion, largest stimulus in U.S. history, enacted in February 2009 that was all deficit spending
Discuss the spending multiplier in terms of deficit spending.
Ratio of a dollar of gov't spending producing a dollar of new output and income. Thus, a stimulus program depends on the size of the tax and the spending multipliers
What do studies suggest help to have a more positive impact on the economy (as opposed to what else)?
Tax cuts seemed to stimulate the economy more and reduce federal deficits more than government spending. The spending multiplier during those times were <1