Fiscal Policy Objectives

Fiscal Policy Objectives
1. What is the difference between discretionary and nondiscretionary fiscal policy? 2. What is the cause-effect chain for expansionary and contractionary fiscal policy? 3. What are the automatic stabilizers? 4. What period is considered the “Golden Age of Fiscal Policy”? 5. What is the “crowding-out” effect? 6. What is the “negative net export effect”? 7. What are the “lags” involved in fiscal policy? 8. What is “Supply-side” economists? 9. What is the Council of Economic Advisers and the Joint Economic Committee?

Even if I have to dig a hole and cover it back up, I do have a job.
Discretionary Fiscal Policy [“G” & “T”] can be used if further smoothing is required. John Maynard Keynes “Father of Fiscal Policy” Nondiscretionary Fiscal Policy can take 33% to 50% of the curves out of the business cycle. [Automatic stabilizers, like welfare and unemploy. insur.] Peak Peak Contraction Contraction Expansion Peak Peak Contraction Contraction Expansion Trough Trough

Introduction This chapter confronts the following questions:
1. Can government spending and tax policies help ensure full employment? 2. What policy actions will help fight inflation? 3. What are the roles of government intervention?

Taxes (“T”) and “G” Spending
Up until 1915, the federal government collected few taxes and spent little. In 1902, it employed fewer than 350,000 people and spent $650 million. Today, it employs nearly 5 million people and spends more than $3 trillion.

Government Revenue Government expansion started with the 16th Amendment to the U.S. Constitution (1913) which extended the taxing power to incomes. Today, the federal government collects over $2.6 trillion a year in tax revenues.

Expansionary Fiscal Policy
Recession and Expansionary Fiscal Policy SRAS AD1 LRAS AD2 Recessions Decrease in AD Price Level PL1 $490 YR $510 YF Real GDP

[Increase “G” or “decrease “T” w. ME of 4]
Expansionary Fiscal Policy [Increase “G” or “decrease “T” w. ME of 4] Full $20 Billion Increase in AD AD1 AD2 LRAS SRAS $5 Billion in additional G spending Price Level PL1 $490 YR $510 YF Real GDP

Is the “real” or “nominal” I.R. used with the LFM graph?
What is the Loanable Funds Market? Is the “real” or “nominal” I.R. used with the LFM graph? “Real I.R.” will be used on the LFM [“r” & nominal I.R. on the money market [i].

D2 S D1 Loanable Funds Market G T r=8% r=6% F1 F2
[*Use this graph if there is a chg in savings by consumers or chg in fiscal policy] [*Use the Money Market graph when there is a change in MS] Loanable Funds Market D2 D1 S Use the “real interest rate” with LFM, because it is long-term. Use “nominal interest rate” with money market, as it is short-term. Borrowers Lenders Starting from a balanced budget, if the G incr spending or decr T to get out of a recession, they would now be running a deficit and have to borrow, pushing up demand in the LFM and increasing the interest rate. Real Interest Rate, (percent) r=8% E2 r=6% E1 $2.2 T $2 T $2 T G T F1 F2 Quantity of Loanable Funds Balanced Budget [G&T=$2 Tr.]

D1 S1 S2 Loanable Funds Market r=6% r=4% F1 F2
[*Use this graph if there is a chg in savings by consumers or chg in fiscal policy] [*Use the Money Market graph when there is a change in MS] Loanable Funds Market D1 S1 S2 Borrowers Lenders Real Interest Rate, (percent) The following would cause an increase in supply in the LFM and lower real interest rates: Fed increases MS HH save more Business save more Government saves more Foreigners save more here r=6% E1 r=4% E2 F1 F2 Quantity of Loanable Funds

Demand for Loanable Funds Market
Demand for Loanable Funds at 3% [no G borrowing] Business firms demand for Loanable Funds at 3% [a lot of investment] Real DI Interest S Rate D1[no G] A 3% A 3% LFM 1.5 QID Low interest rates, so - a lot of investment Trillions of Dollars Trillions of Dollars

Demand for Loanable Funds Market Higher interest rates, so
With “G” borrowing, the demand for LF goes to 5% Business firms demand for Loanable Funds at 5% [not as much investment] Government Demand for Funds Business Demand for Funds D2(G) DI Real S Interest Rate D1[no G] B 5% 5% B A 3% 3% A Higher interest rates, so not as much investment 1.0 LFM 1.5 QID2 QID1 Trillions of Dollars Trillions of Dollars

Balanced Budget [$2 Tril. “G” = $2 Tril. “T”]
Recession Incr G to $2.2 or Decr T to $1.8 $2 Trillion $2 Trillion Deficit so higher I.R. Gonna have to borrow G T So expansionary fiscal policy leads to higher interest rates. Deficit Inflation Decr G to $1.8 or Incr T to $2.2 Surplus so Lower I.R. Budget Wow! A surplus So, contractionary fiscal policy leads to lower interest rates.

Loanable Funds Market [Incr G; Decr T] [But we get negative Xn] D2 S D1 SRAS r=8% PL AD2 Real In. Rate Start from a Balanced Budget G & T = $2 Trillion r=6% LRAS AD1 F1 F2 “Now, this is better.” $2.2 tr. “I can’t get a job.” PL2 $2 tr. $2 tr. PL1 E2 G T E1 YR YF Real GDP $2.2 $2.2 G G I.R. AD Y/Empl./PL; LFM $1.8 $1.8 T Y/Emp/PL; DI C AD T LFM IR

Contractionary Fiscal Policy
Loanable Funds Market [Decr G; Incr T ] [Again, we get negative Xn] D1 D2 S PL r=6% SRAS r=3% Real In. Rate Start from a Balanced Budget G & T = $2 Trillion AD2 LRAS F2 F1 PL1 $2.2 T tril. E1 $2 tril. $2 T tril. $1.8 tril.. PL2 G T E2 AD1 YF YI Real GDP [like we have “money trees”] $1.8 $1.8 G G I.R. AD Y/Empl./PL; LFM $2.2 $2.2 T Y/Emp/PL; DI C AD T LFM IR

Nondiscretionary Fiscal Policy
Deliberate use of government spending and/or taxing. “G” and “T” Nondiscretionary Fiscal Policy Automatic Stabilizers 1.Welfare & food stamps 2. Unemploy. insurance 3. Social security 4. Corporate Dividends 5. Progressive Tax System Unempl. check Discretion of Congress

Suppose the economy is in recession:
Fiscal Policy [Automatic stabilizers] Suppose the economy is in recession: Tax collections Real GDP Transfer payments AS AD1 AD2 G > T PL The deficit grows YR Y* “Recession”

If the economy has an inflationary gap:
Fiscal Policy [Automatic stabilizers] If the economy has an inflationary gap: Tax collections Real GDP Transfer payments AS AD2 PL AD1 G < T Y* YI The surplus grows “Inflationary Gap”

Discretionary [“Active”] Fiscal Policy [“G” & “T”]
[in a nutshell] Contractionary Fiscal Policy Decrease “G” Increase “T” AS AD2 AD1 AD3 PL2 PL1 PL3 Peak Peak YR YF YI Peak Expansion Peak Contraction Expansionary Fiscal Policy Increase “G” Decrease “T” Trough Trough [Takes about 1/3 to ½ out of the curves]

“Balance the economy over the course of the Business Cycle”
Keynesian Policy “Balance the economy, not the budget.” Peak Peak Raise “T” Raise “T” AS AD2 AD1 AD3 PL2 Trough Deficit Spending Raise Taxes Deficit Spending PL1 “Balance the economy over the course of the Business Cycle” PL3 YR YF YI Bus. Cycle “Even if the jobs are digging holes and filling them up.” Recess – Lower T Deficits Inflat – Raise T Surpluses

[Is borrowing or printing the money more expansionary?]
FINANCING OF DEFICITS [Is borrowing or printing the money more expansionary?] 1. Government borrows from the public [results in higher interest rates which crowds out investment] Higher I.R. MS1 2. Just print the money [Money creation – lower interest rates so this would be more expansionary] MS2 7% 4% Lower I.R. But the LR increase in MS results in an increase in inflation AS AD2 AD1 PL2 PL1 Y* Y

[Should we hold the surplus or give it back]
How To dispose of Surpluses [Should we hold the surplus or give it back] 1. Debt Retirement [Give the surplus back during recessions to get lower interest rates and expand the economy] 2. Impound The Surplus [Keep the surplus during inflations and give it back during recessions] AS AD2 AD1 PL2 PL1 Y* YI

What is the "Crowding-out" Effect?

Friedman s G IG YR Y* [Incr G incr I.R. Decr Ig] "Crowding-out" Effect
Loanable Funds Market 10% 8% 6% 4% 2% PL AS D2 s Real I.R. AD2 D1 AD1 4% 2% G 10% Real interest rate Crowding Out Effect 6% IG YR Y* F1 F2 15 Quantity of LF Investment (billions of dollars) In this case, it would be 100% “crowding out”. [The higher RIR could also cause crowding-out of Xn.] G can finance a deficit by: 1. Borrowing - this raises interest rates in the LFM and “crowds out” investment. 2. Money Creation - no “crowding out” so is more expansionary than borrowing. Friedman Just follow the “monetary rule.”

Negative Net Export Effect of Fiscal Policy “Negative Xn” Expansionary Fiscal Policy Due to higher interest rates, dollar appreciates LRAS SRAS AD AD +G +C +Ig AD -Xn YR Y*

Expansionary Fiscal Policy Contractionary Fiscal Policy
Negative Net Export Effect of Fiscal Policy “Negative Xn” of “Negative Xn” of Expansionary Fiscal Policy Contractionary Fiscal Policy Due to lower interest rates, dollar depreciates Due to higher interest rates, dollar appreciates LRAS SRAS AD LRAS SRAS AD -Ig -C -G +G AD +C +Ig +Xn -Xn YR Y* Y* YI

Liberal (“G”) or Conservative (“G”)
Liberals Recession: Increase “G”; Inflation: Increase “T” G Conservatives Recession: Decrease “T”; Inflation: Decrease “G” G

Fiscal Policy lags Data (recognition) lag
“The shower starts out too cold, because the pipes have not yet warmed up. So the fool turns up the hot water. Nothing happens, so he turns up the hot water further. The hot water comes on and scalds him. He turns up the cold water. Nothing happens right away, so he turns up the cold further. When the cold finally starts to come up, he finds the shower too cold, and so it goes.” Fiscal Policy lags Data (recognition) lag “Wait-and-see” lag – short run Legislative lag (political) Effect lag [takes months]

The G is like a “Fool in the Shower.”
Discretionary fiscal policies intended to fight a recession often end up feeding a boom and vice versa. E4 LRAS SRAS1 AD1 AD2 SRAS2 E1 E2 E4 E3 YR YF YI E2 All too often, policy makers can inadvertently exacerbate rather than mitigate the magnitude of economic fluctuations.

Traditional Fiscal Policy [“G” & “T”] will not work with Stagflation
SRAS2 AD1 LRAS 15% 10% AD3 4% 15% 10% YR 5% Stagflation YR YF

THE LAFFER CURVE 100 Tax rate (percent) l Tax revenue (dollars)

THE LAFFER CURVE 100 Tax rate (%) m l Tax revenue (dollars)

THE LAFFER CURVE 100 n Tax rate (percent) m l Tax revenue (dollars)

THE LAFFER CURVE Maximum Tax Revenue Tax rate (%)
100 n m m Maximum Tax Revenue Tax rate (%) l Tax revenue (dollars)

Supply-Side Economics [Voodoo Economics?]
Shift the AS curve back to the right 1. Reduce corporate taxes from 50% to 35% [they have more money and increase investment, so more jobs] 2. Accelerated depreciation of capital investment from 10 years to 3 years [businesses save taxes enabling them to invest more] 3. Reduce personal income taxes by $250 billion [keeping more of our money makes us work harder & longer; also, we buy more, so more jobs and in addition, we save more, which lowers interest rates, which increases Ig] 4. Tax Credits for R&D [businesses have more money, so more Ig and more jobs] Motto: Get the government off our [ regulations] backs & watch the AS curve shift. StagFlation Was President Reagan a “closet Keynesian” with all the “G” & “T”? Perhaps he was a “Keynesian in drag.” AS2 AS1 AD PL 10% 3% 10% 5%

b c a b The Laffer Curve Tax revenue (dollars) 100 Tax rate (percent)
President Reagan said he was on the Laffer curve. He said that after WWII, when he started making big money, that he could do 4 movies before making $200,000 and hitting the top marginal tax rate of 91%. After four, because he could only keep 9%, he would quit making movies until the next year. “Yes, I was on the Laffer cuve. I couldn’t shoot my way out” b Maximum Tax Revenue c a Tax revenue (dollars) Reagan The “Gipper” b Bonzo 100 Tax rate (percent) For rich people, this was a disincentive to keep working, so they would quit when they hit the top marginal tax rate. For most workers, this was not the case.

SUPPLY-SIDE FISCAL POLICY
Can sustain a much greater increase in AD if the AS curve is also shifting to the right. AD1 AD2 AS1 AS2 Price level PL2 PL1 10% PL3 Q1 Q2 Q3 Real GDP 10%

MULTIPLIER WITH PL CHANGES
Inflation and the Multiplier [4] AS Full Multiplier Effect Reduced Multiplier Effect Due to Inflation AD3 AD2 AD1 +20 +20 Price Level P2 P1 + 40 bil. + 80 bil. GDP1 GDP2 GDP3 M(4) = Y/ E [80] [20] M(2) = Y/ E [40] [20]

EXPANSIONARY FISCAL POLICY
[MPS=.25] the multiplier at work... $5 billion initial direct increase in spending AS AD1 AD2 Full $20 billion increase in AD +5 Price level PL $485 $505 Real GDP (billions)

CONTRACTIONARY FISCAL POLICY direct decrease in spending
[MPS=.25] the multiplier at work... AS AD2 AD1 PL1 $5 billion initial direct decrease in spending Price level PL2 Full $20 billion decrease in AD $515 Real GDP (billions)

Government Expenditures,
Built-In Stability 50% More vertical [more progressive], the more stability for the economy. Taxes Even more Tax money Taxes 35% Transfers More tax money More Transfers Government Expenditures, G, and Tax Revenues, T Surplus Deficit Gov. purchases Fewer Transfers Less Tax Money Fewer Transfers 10% But larger deficits 5% GDP1 GDP2 GDP3 YR Y* YI Real Domestic Output, GDP

Automatic Stabilizers
Nondiscretionary [“Passive”] Fiscal Policy (Automatic stabilizers) 1. Transfer Payments D. Corporate dividends A. Welfare checks E. Social Security B. Food Stamps F. Veteran’s benefits C. Unemployment checks 2. Progressive Income Taxes AD2 AS AD1 AD3 Automatic stabilizers take 33-50% out. Stabilizers are like a thermostat maintaining temperature. They are shock absorbers. 33%-50% YR Y* YI YR ; T ; AD2 YI ; T ; AD3 Taxes reduce the drop in DI during recessions and reduces the jump in DI during expansions. Automatic Stabilizers The automatic stabilizers may be called the automatic pilot of our economy, not very well suited for takeoffs and landings, but fine for the smooth part of the the flight. But when the going gets rough, the economy must use manual controls. [discretionary G&T] A pilot may take a stroll thru and let the co-pilot cruise. If there is turbulence, the pilot will rush to the cockpit [President & Congress] and use manual controls to correct turbulence. Discretionary fiscal policy is our manual control system.

Mixed - Open ADDING THE PUBLIC SECTOR [“G”]
$20 Billion Government Spending & Impact on Equilibrium Y Government Spending of $20 Billion C + Ig + Xn + G C + Ig + Xn $20 bil. on National Defense $550 Consumption $470 Increases Y by $80 [$20 x 4 = $80] Private-public - ROW $390 Mixed - Open AE (billions) 45 o o RGDP 550

Mixed-Open Incr. T by $20 billion [MT = 3] Equilibrium GDP[-60]
ADDING THE PUBLIC SECTOR [“G”] Incr. T by $20 billion [MT = 3] Equilibrium GDP[-60] C + Ig + Xn + G Ca + Ig + Xn + G $20 bil. incr in T $550 $490 Mixed-Open -20 x 3 = -$60 45 o o RGDP $490 $550 Real domestic product, GDP (billions of dollars)

[“T” affects AD indirectly thru “C”; “G” affects AD directly]
Balanced Budget Multiplier [$20 billion] [“T” affects AD indirectly thru “C”; “G” affects AD directly] GDP=$80 Net Change in GDP = +$20 The increase in “G” flows directly into the economy. The increase in “T” means we would have consumed $15 and kept $5 in our pockets. GDP= -$60 T $20 Sa= -$5 G $20 Ca= -$15 ME = 1/MPS ME = 1/.25 = 4 So, 4 x $20 = $80 MT = MPC/MPS=.75/.25=3 So, 3 x -$20 = -$60 AS AD1 AD2 PL $490 billion $470 billion

Fiscal Policy NS 1-8 1. With the Employment Act of 1946, the federal government committed itself to accept (total/some) degree of responsibility for employment/prices. 2. Fiscal policy is carried out primarily by the (local/state/federal) government. 3. Discretionary fiscal policy [G & T] (does/does not) require congressional action. 4. In a mixed [private & public) closed economy, taxes & (savings/government spending) are leakages, while Ig and (savings/government spending) are injections. 5. In a mixed economy, the equilibrium GDP exists where (C+Ig/C+Ig+G+Xn)=GDP. 6. The balanced budget multiplier indicates that equal increases in G&T tend to (decrease/increase/not change) the equilibrium GDP. [MBB is “1”] 7. Assume in a private economy that equilibrium GDP is $400 billion & the MPC is .80. Suppose the G collects new taxes of $50 bil. & spends the entire amount on our infrastructure. As a result equilibrium GDP will be ($400/$450/$500) billion. 8. Suppose a constitutional amendment requires that the G always balance its budget. If it desired to increase GDP by $40 billion, G should (increase/decrease) government spending & taxes by ($30/$40/$50) billion.

C YR YI A AE2 9. In a severe recession, Keynesians PL
would favor a(n) (increase/decrease) in taxes. AE2 PL AE1 YR Y* ? 10. If the government tries to eliminate a budget deficit during a depression, these efforts will (help/hurt) the depression. 11. A conservative economist who advocates an active fiscal policy would recommend tax (increases/decreases) during a recession and (increases/decreases) in government spending during inflation. AE PL O C YI YR A 12. If the F.E. GDP is OC, then it would be appropriate fiscal policy for government to (increase/decrease) “G” and (increase/decrease) “T”. 13. If the F.E. GDP is OA, then it would be appropriate fiscal policy for

surplus will occur when the G (impounds/uses) the surplus
14. If G increases its spending during a recession to assist the economy, the funds must come from some source. (Additional taxes/Borrowing from the public/Creating new money) would tend to be the most expansionary. 15. The following fiscal actions, (incurring a budget surplus and allowing it to accumulate as idle Treasury balances/ incurring a budget surplus which is used to retire debt held by the public) is likely to be most effective in curbing inflation. 16. The greatest anti-inflationary impact of a budget surplus will occur when the G (impounds/uses) the surplus funds & lets them (stand idle/pay off the debt). 17. In describing the built-in stabilizers, we can say that personal & corporate income tax collections automatically (incr/decr) as GDP increases & transfers and subsidies (incr/decr) as GDP increases. Should I give it back?

Recognition, Action, & Effect Lags of Fiscal Policy
Recognition Lag Action Lag Effect Lag

FISCAL POLICY – Pure and Simple
There are 3 things that could “diminish AD.” AD1 AD2 AS Fiscal Policy: No Complications PL Price level $490 YR $510 Y* Real GDP (billions)

Three things that could “diminish AD.”
1. Crowding-out Effect 2. Net Export Effect 3. Inflation AD1 AD’2 AD2 AS Net Export Effect Expansionary fiscal policy leads to more government borrowing, increasing the interest rate, appreciating the dollar, & decreasing Xn. PL Crowding-out Effect Increasing G results in higher interest rates, decreasing investment and the . . . $ $510 $503 Real GDP (billions)

3. Inflation would be a third factor
that could reduce aggregate demand AS AD2 AD1 Price level P1 $495 $505 $515 Real GDP (billions)

NS 18-21 T2 1 Answer the next 3 questions(18-21) based on the diagram.
[50%] T2 35% 1 10% 5% Answer the next 3 questions(18-21) based on the diagram. 18. Deficits will be realized at GDP levels (below/above) C, and surpluses (below/above) C. 19. If the F.E. GDP for the economy is at D, the F.E. budget will entail a (deficit/surplus). 20. If the tax line had a greater slope [more progressive tax system], stability would be (less/greater). 21. If government adhered strictly to an annually balanced budget then the government’s budget would tend to (destabilize/stabilize) the economy.

NS 22-25 Tax Revenue YR Y* YI GDP For Questions 22-24 [graph]
50% (represents a more progressive system) [T3] 35% 25% [T2] Tax Revenue Flat 20% Tax 20% 20% [T1] 15% 10% 5% YR Y* YI GDP For Questions [graph] 22. (T1/T4) tax system is characterized by the least built-in stability. 23. (T1/T4) tax system is characterized by the most built-in stability. 24. (T1/T4) tax system will generate the largest cyclical deficits. 25. Nondiscretionary Fiscal Policy (does/does not) require congressional action.

NS 26-30 26. If the MPC is .5, a $10 B increase in “G” will increase “C” [not income] by ($20/$10/$5) billion. [G increase in spending of $10 B increases income(Y) by $20 B. With MPC of .5, C increases $10 B] 27. If government tries to give back a surplus during an inflationary FE year, this will be (pro-cyclical/counter-cyclical). 28. When politicians use fiscal policy to cause an improvement in the economy just prior to an election, this is a (presidential/Congressional/political) business cycle. 29. When G incurs a deficit which is financed by borrowing, causing interest rates to increase which decreases Ig, this is called the (crowding-in/crowding out) effect. 30. Supply-siders argue that the primary effect of tax cuts is to shift the AS curve (leftward/rightward).

NS 31-34 AE billion, & the level of investment is $10
31. If the MPC is .8, a $2 billion increase in “G” will increase “consumption” by ($10/$8/$6) billion. [When G increases by $2 billion, Y does increase by $10, but *8 (80%) is consumed, or $8 billion] 32. If the MPC is .9, a $1 billion increase in “G” will increase “consumption” by ($10/$9/$8) billion. S C+Ig AE 33. In a private-closed economy, the MPS is .2, consumption equals income at $200 billion, & the level of investment is $10 billion. The level of income at the new equilibrium level is ($200/$250) billion. “C” +$10 Ig 200 ? S 34. If the MPS is .2 and the economy has a recessionary spending gap of $5 bil., we may conclude that the equilibrium level of GDP is ($5/$20/$25) below the FE GDP. AE2 AE AE1 +$5 YR ?

NS 35-38 S 35. If the MPS is .5 and the economy has an inflationary spending gap of $6 billion, we may conclude that the equilibrium level of GDP is ($6/$12/$18) billion beyond the FE GDP. AE AE1 AE2 -$6 Y* YI 36. If the government decreases G&T by $10 billion, then a MPS of .10, the equilibrium GDP would (increase/decrease) by ($5/$10/$100) billion. 37. With a MPC of .75, government increases G&T by $8 billion. The equilibrium GDP (increases/decreases) by ($75/$32/$8) billion. 38. If the government runs a budget surplus and desires to curb inflation, it should (give the surplus back/keep it in storage).

Fiscal Policy Test Review 1-2
1. Expansionary fiscal policy will be most effective [increase GDP] when the AS curve is (vertical/horizontal) & (incr/decr) “C” and (incr/decr) unemployment. 2. The paradox of thrift indicates that an increase in saving (matched/unmatched) by an increase in investment will lower equilibrium GDP.

Fiscal Policy Test Review 3-4
[On #3, start from a balanced budget] 3. A contractionary fiscal policy [decr G, incr T] would cause a[an] (incr/decr) in output[GDP] and a[an] (incr/decr) in interest rates. An expansionary fiscal policy [incr G, decr T] would cause a[an] 4. In the AE model, if AE[AD]doesn’t buy up FE output(GDP), then the equilibrium output is (less than/more then) full employment output. G $2 Trillion T $2 Trillion [G ; LFM ; In. Rates ] [T ; LFM ; In. Rates ] [G ; LFM ; In. Rates ] [T ; LFM ; In. Rates ] “Recessionary Gap” “Inflationary Gap”

5. To decrease AD the greatest amount, the government should:
(decrease “G” only/increase “T” only/both decr G & incr T) 6. To increase AD the greatest amount, the “G” should: (increase “G” only/decrease “T” only/both incr G and decr T) 7. In a recessionary gap (AE model) at the equilibrium point[actual GDP] planned investment is (greater than/equal to/less than) saving, but at the FE GDP level, planned investment[backup] is (greater than/equal to/less than) saving. 8. In an inflationary gap (AE model), at the equilibrium point [actual GDP] planned investment [backup] is (greater than/equal to/less than) saving, but at the FE level, planned investment is (greater than/equal to/less than) saving. 9. If businesses are experiencing an unplanned increase in inventories, AE is (less than/greater than) FE output & spending will (increase/decrease). 10. If businesses are experiencing an unplanned decrease in inventories [disinvestment] AE is (less than/greater than) FE output & spending will (increase/decrease).

11. If “C” equals income at $500 billion, & MPC is .9, then an
increase in Ig of $10 billion will change equilibrium GDP to ($400/$490/$510/$600) billion. 12. A conservative economist would want tax (incr/decr) during a recession & (incr/decr) in “G” during inflationary times. 13. A liberal economist would want tax (incr/decr) during an inflation & (incr/decr) in “G” during recessionary periods. 14. An inflationary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP. 15. A recessionary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP. 16. To increase GDP [but reduce military spending], we would combine two (domestic/overseas) bases into one (domestic/overseas) base. 17. A tax cut to expand the economy would (incr/decr) Y & (incr/decr) in. rates. 18. A tax increase to contract the economy would (incr/decr) Y & (incr/decr) IR.

Test Review 19-22 19. To increase equilibrium GDP by $400,000,
with a MPC of .5, a Keynesian economist would (decrease “T”/increase “G”) by $200,000. 20. Equilibrium GDP is $500 billion and MPS is .4. Now “G” collects taxes of $22 billion and spends the entire amount. As a result, equilibrium GDP will change to: ($445/$478/$522/$555). 21. With a MPC of .5, a $12 billion increase in “G” will increase “C” by ($12/$24/$36) bil. 22. With a MPC of .5 and the economy in a recessionary spending gap of $12 billion, we may conclude that the equilibrium is ($12/$24/$36) billion short of FE GDP.

Test Review 23-27 23. An increase in Ig of $25 billion results in an increase in equilibrium income (GDP) of $50B, so the MPS is? 24. A contractionary fiscal policy results in a(n) (incr/decr) in output, and a(n) (incr/decr) in interest rates. 25. Increasing T or decreasing G will (increase/decrease) consumption, and (increase/decrease) unemployment. 26. With a MPC of .5, and the economy with an inflationary GDP Gap of $50B, G could eliminate this inflationary GDP Gap by reducing government spending by? 27. With a MPC of .5 and current output at $500 billion but FE output is $700 billion, correct fiscal policy would be to (increase G/decrease T) by $100 billion. .5 [Incr T or Decr G] $25 billion

Test Review 28-33 28. An increase in Ig in an economy
(increase)/decrease) GDP & (increase/decrease) C. 29. In a recessionary economy, at FE GDP, saving is (less than/more than) Ig. 30. In a recessionary economy, (actual Y/potential Y) exceeds (actual Y/potential Y). 31. In a mixed-closed economy (no Xn), the leakages are? and the injections are? 32. If the economy has an inflationary Gap, at FE GDP, saving (exceeds/is less than) Ig. 33. If there is an equal increase in G&T of $25 billion, then output will (increase/decrease) & interest rates [based on PL] will (increase/decrease). [S & T] [G & Ig]

E-con The End

Fiscal Policy Objectives

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