CHAPTER 12

Fiscal Policy
A. Short-Answer, Essays, and Problems
New 1. Give a brief definition of fiscal policy? What are its economic goals? New 2. What is the Council of Economic Advisers? 3. The Employment Act of 1946 is no more than a vague and ill-defined commitment by the Federal government to assist in the achievement of full employment. Do you agree? Explain. 4. Explain the effect of a discretionary cut in taxes of $40 billion on the economy when the economys marginal propensity to consume is .75. By how much is output likely to expand if the economy is operating in the horizontal range of its aggregate supply curve and there are no complications to this fiscal policy? How does this discretionary fiscal policy differ from a discretionary increase in government spending of $40 billion? 5. Explain the effect of a discretionary increase in government spending of $50 billion on the economy when the economys marginal propensity to consume is .75. By how much is output likely to expand if the economy is operating in the horizontal range of its aggregate supply curve and there are no complications to this fiscal policy? 6. Explain the aspects of expansionary and contractionary fiscal policy. During which phases of the business cycle would each be appropriate? 7. Differentiate between discretionary fiscal policy and nondiscretionary or built-in stabilization policy. 8. Describe two ways the Federal government can finance a deficit and explain which would have the more expansionary effect. 9. Describe two ways the Federal government could retire debt in the event of a budget surplus and explain which would have the most contractionary impact. 10. What is the anti-inflationary or contractionary effect of a budget surplus? 11. Explain how a small budget surplus could actually be somewhat expansionary rather than contractionary. 12. Explain what is meant by a built-in stabilizer and give two examples. 13. The more progressive a tax system, the greater is the economys built-in stability. Explain this statement for both recessionary and peak phases of the business cycle. 14. Explain how the below graph illustrates the built-in stability of a progressive tax structure.

15. In Year 1, the full-employment budget showed a deficit of about $100 billion and the actual budget showed a deficit of $150 billion one year. In Year 2, the full employment budget showed a deficit of about $125 billion and the actual budget showed a deficit of $150 billion. Based on these data, what can be concluded about the direction of fiscal policy? 16. What is the difference between the actual deficit, the full-employment deficit, and the cyclical deficit? 17. What does the full-employment budget measure and of what significance is this concept? New 18. Complete the table below by stating whether the direction of discretionary fiscal policy was contractionary (C), expansionary (E), or neither (N), given the hypothetical budget data for an economy. (1) (2) Actual budget deficit () or surplus (+) 3.9% 4.5 4.7 3.9 2.9 2.2 (3) Full-employment budget deficit () or surplus(+) 2.1% 2.6 3.0 2.6 2.0 1.9 (4) Direction of fiscal policy _____ _____ _____ _____ _____

Year 1 2 3 4 5 6

19. In what fundamental way do the spending-taxation decisions of government differ from the consumptionsaving plans of households? Why is this difference significant? 20. Identify the problems or complications which arise in the implementation of fiscal policy. 21. If economic forecasting was a more exact science, the business cycle could be entirely corrected by fiscal measures. Do you agree? 22. Explain the crowding-out effect. 23. Using the below graph, illustrate the possible impact of a crowding-out effect of a fiscal policy by drawing in the relevant aggregate demand shifts. Label and explain any shifts in the demand curve shown.

24. Comment on the statement: Discretionary fiscal policy offers an ideal approach to dealing with the nations economic problems. 25. Explain how the net-export effect would reduce the effectiveness of fiscal policy.

New 26. What fiscal policy is most likely to be invoked during a period of rapid inflation? A period of severe unemployment? What political, investment, and international problems might Congress encounter in enacting these policies and putting them into effect? 27. Contrast supply-side fiscal policy with demand-side fiscal policy. 28. What is supply-side fiscal policy? What is the rationale for it? Is it effective? 29. Using the aggregate demand-aggregate supply diagram shown below, draw in relevant curves to indicate potential supply-side effects of a tax decrease. Explain the outcome of your illustrated shift in terms of the new equilibrium quantity and price level.

New 30. (Last Word) What is the purpose of the Conference Boards index of leading economic indicators? New 31. (Last Word) Why is the index of leading economic indicators a composite index of ten economic statistics and not just one? Not in Ch 12: What are the three principal tools of monetary policy? Explain how they can be used. The Federal Reserve Banks use three principal tools (techniques or instruments) to control the reserves of banks and the size of the money supply. (1) The Federal Reserve can buy or sell government securities in the open market to change the lending ability of the banking system: (a) buying government securities in the open market from either banks or the public increases the excess reserves of banks; (b) selling government securities in the open market to either banks or the public decreases the excess reserves of banks. (2) The Fed can raise or lower the reserve ratio: (a) raising the reserve ratio decreases the excess reserves of banks and the size of the monetary (checkable-deposit) multiplier; (b) lowering the reserve ratio increases the excess reserves of banks and the size of the monetary multiplier. (3) The Fed can also raise or lower the discount rate: (a) raising the discount rate discourages banks from borrowing reserves from the Fed; (b) lowering the discount rate encourages banks to borrow from the Fed. [text: E pp. 284289; MA pp. 284-289]