FISCAL POLICYFISCAL POLICY[“G” and “T”][“G” and “T”]

Even if I have to dig a hole and cover it back up, I do have a job.

John Maynard KeynesJohn Maynard Keynes““Father of Fiscal Policy”Father of Fiscal Policy”

IntroductionIntroduction• This chapter confronts the following questions:

1. Can government spendinggovernment spending and and tax tax policiespolicies help ensure full employment?

2. What policy actions will help fight inflationfight inflation?

3. What are the roles of roles of government government interventionintervention?

TTaxes (“T”)axes (“T”) andand “G”“G”SpendingSpending

• Up until 19151915, the federal government collected few taxes and spent little.

• In 19021902, it employed fewer than 350,000350,000 peoplepeople and spentspent $650 $650 millionmillion..

• Today, it employs nearly 4.3 million4.3 million peoplepeople and spends more than $3.4 $3.4 trilliontrillion.

Government RevenueGovernment Revenue• Government expansion started with the 16th 16th

AmendmentAmendment to the U.S. Constitution (19131913)

which extended the taxing power to incomes.

• Today, the federal government collects over $2.7$2.7 trilliontrillion a year in tax revenues.

The next picture is a kilometer-long “concrete bathtub” water The next picture is a kilometer-long “concrete bathtub” water bridge near the town of Magdeburg.bridge near the town of Magdeburg.

Let’s say the German government decides to connect East Let’s say the German government decides to connect East

Germany to West Germany by constructing a Germany to West Germany by constructing a water bridgewater bridge

over theover the Elbe River. They did this, spending 500 million euros. Elbe River. They did this, spending 500 million euros.

Re

al I

nte

res

t R

ate

, (p

erc

en

t)

Quantity of Loanable Funds

Loanable Funds MarketLoanable Funds Market[*Use this graph if there is a chg in savings by consumers or chg in fiscal policy][*Use this graph if there is a chg in savings by consumers or chg in fiscal policy]

[*[*Use theUse the Money Market graphMoney Market graph when there is awhen there is a change in MSchange in MS]]

IIRR==88%%

DD11

FF11

SS

Starting from a balanced budgetbalanced budget, if theG incr spendingG incr spending or decr Tdecr T to get out ofa recessionrecession, they would now be runninga deficitdeficit and have to borrow, pushing pushing up demand in the LFMup demand in the LFM and increasing increasing the interest ratethe interest rate.

DD22

IIRR==1010%%

FF22

EE11

EE22

Use the “real interest rate”“real interest rate” withLFMLFM, because it is long-termlong-term.Use “nominal interest rate”“nominal interest rate” withmoney marketmoney market, as it is short-termshort-term. BorrowersBorrowers LendersLenders

$$2 T2 T $2 T$2 T

GG TT

Balanced Budget [G&T=$2 Tr.]Balanced Budget [G&T=$2 Tr.]

Demand for Loanable Funds MarketDemand for Loanable Funds Market(a)(a) (b)(b)

Demand for Loanable

Funds at 3% [no G borrowing]

Business firms demand for

Loanable Funds at 3%[a lot of investment]

RateInterest

3%3%

SSDD1[1[nono G]G]

LFMLFM

AA AA

Trillions of DollarsTrillions of Dollars

3%3%

1.51.5

Trillions of DollarsTrillions of Dollars QIDQID

DDII

Low interest rates, so Low interest rates, so - a lot of investment- a lot of investment

RealReal

BusinessesBusinessesBusinesses

Demand for Loanable Funds MarketDemand for Loanable Funds Market(a)(a) (b)(b)

RateRateInterestInterest

3%3%

SSDD1[1[nono G]G]

LFMLFM

AA

Trillions of DollarsTrillions of Dollars

3%3%

1.51.5

Trillions of DollarsTrillions of Dollars

DDII

With “G” borrowing, the With “G” borrowing, the

demanddemand for for LFLF at at 55%%

Business firms dBusiness firms demandemand for for

LoanableLoanable Funds at Funds at 55%%[not as much investment][not as much investment]

DD22(G)(G)

5%5% BB

QQIIDD22 QQIID1D1

Higher interest rates, soHigher interest rates, sonot as much investmentnot as much investment

55%%

1.01.0

Government Demand for FundsGovernment Demand for Funds Business Demand for FundsBusiness Demand for Funds

AA

BB

RealReal

Gonna have Gonna have to borrowto borrow

BBalancedalanced BBudget [$2 Tudget [$2 Tril. ril. “G” = $2 T“G” = $2 Tril. ril. “T”]“T”]

$2 $2 TrillionTrillion $2 $2 TrillionTrillion

GG TT

RecessionRecessionIncr G to $2.2 Incr G to $2.2

or or

Decr T to $1.8 Decr T to $1.8

DeficitDeficit so sohigher I.R.higher I.R.

InflationInflationDecr G to $1.8Decr G to $1.8

or or

Incr T to $2.2Incr T to $2.2

Surplus Surplus sosoLower I.R.Lower I.R.

BudgetBudget

So expansionary fiscal policySo expansionary fiscal policyleads to leads to higher interest rates.higher interest rates. DeficitDeficit

Wow! AWow! Asurplussurplus

So, contractionary fiscal policySo, contractionary fiscal policy

leads to leads to lower interest rateslower interest rates..

Real GDPReal GDP

PLPL SRASSRASADAD22

YYRR YYFF

[[Incr GIncr G;; Decr TDecr T]]

PPL1L1

ADAD11

PLPL22

GG ADAD Y/Empl./PL;Y/Empl./PL; GG LFMLFM II.R..R.

TT DDII CC ADAD Y/Emp/PL;Y/Emp/PL; TT LFMLFM IIRR

Start from a Start from a Balanced BudgetBalanced BudgetG & T = $2 TrillionG & T = $2 Trillion

$$2 T2 T $2 T$2 T

““I can’t I can’t get a job.”get a job.”

““NNowow, , this isthis is better.”better.”

GG TT EE11EE22

LRASLRAS

Real GDPReal GDP

PL SRASSRAS

ADAD22

YYIIYYFF

[[Decr G; Decr G; Incr TIncr T to close ato close a contractionary gapcontractionary gap]]

PPL1L1

ADAD11

PLPL22

GG ADAD Y/Empl./PL;Y/Empl./PL; GG LFMLFM II..R.R.

TT DDII CC ADAD Y/Emp/PL;Y/Emp/PL; TT LFMLFM IIRR

Start from a Start from a Balanced BudgetBalanced BudgetG & T = $2 TrillionG & T = $2 Trillion

$2T$2T $2T$2T GG TT

[like we have[like we have ““money trees”money trees”]]

EE11

EE22

LRASLRAS

Everyone Wants To Go To HeavenEveryone Wants To Go To HeavenBut No One Wants To Die.But No One Wants To Die.

Everyone Wants Government SpendingEveryone Wants Government SpendingBut No One Wants To Pay Taxes.But No One Wants To Pay Taxes.

Expansionary Expansionary Fiscal PolicyFiscal Policy

Recessionary GapRecessionary Gap

TTGG

SRASSRAS

AD2AD2

YYRR YY**

AD1AD1

Keynes and Lydia LopokovaKeynes and Lydia Lopokova

LLRASRAS

Expansionary Expansionary Fiscal PolicyFiscal Policy

Inflationary GapInflationary Gap

TT

GG

SRASSRAS

AD2AD2

YY** YYII

AD1AD1

Contractionary Contractionary Fiscal PolicyFiscal Policy

GG

TT

LLRASRAS

The automatic stabilizers may be called the automatic pilotautomatic pilot of our economyof our economy, not very well suited for takeoffs and landings, but fine for the smooth part of the flight. But when the going getsgoing gets roughrough, the economy must use manual controlsmust use manual controls. [discretionary G&Tdiscretionary G&T]

Nondiscretionary Fiscal Policy (Automatic stabilizers)Nondiscretionary Fiscal Policy (Automatic stabilizers)1. Transfer PaymentsTransfer Payments

A. Welfare checks B. Unemployment checks C. Food Stamps D. Social SecurityE. Corporate dividends F. Veteran’s benefits

2. Progressive Income TaxesProgressive Income Taxes

Automatic stabilizersAutomatic stabilizerstake take 33-50%33-50% out. out.SStabilizerstabilizers are like aare like a thermostat thermostatmaintaining temperature.maintaining temperature.They are shock absorbers.They are shock absorbers.

YYRR ; ; TT ; ; ADAD22

YYII ; T ; AD ; T ; AD33

ADAD22

ADAD22

ADAD33

YYR R Y* Y* YYII

ASAS

3333%-%-5050%%

A pilot may take a stroll thrupilot may take a stroll thru & let the co-pilot cruiseco-pilot cruise. If there is turbulenceturbulence, the pilot will rush back to the cockpitpilot will rush back to the cockpit [President & Congress] and use manualuse manual controlscontrols to to correct correct economic turbulenceeconomic turbulence. Discretionary Discretionary fiscal policy is our manual control systemfiscal policy is our manual control system.

GDPGDP11 GDPGDP22 GDPGDP33

Real Domestic Output, GDPReal Domestic Output, GDP

Go

ve

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en

t E

xp

end

itu

res,

Go

ve

rnm

en

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xp

end

itu

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G, a

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Tax

Re

ven

ues

, TG

, an

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ax R

eve

nu

es, T

DeficitDeficit

More taxMore taxmoneymoney

TaxesTaxes

GGov. ov. purchases purchases by Fed,by Fed, state state and local and local govegovernmenrnmentsts

YYRR Y*Y* YYII

More vertical [more progressive], More vertical [more progressive], the more stability for the economy.the more stability for the economy.

TransfersTransfers

SurplusSurplus

Fewer Fewer TransfersTransfers

MoreMoreTransfersTransfers

Less TaxLess TaxMoneyMoney

12-31-6512-31-65

FewerFewerTransfersTransfers

TaxesTaxes

Keynesian Keynesian ModelModel

Recess.

GapInflat.Gap

Discretionary Discretionary Fiscal Policy Fiscal Policy

Deliberate use of government spending and/or taxing.

““G” and “T”G” and “T”

Nondiscretionary Nondiscretionary Fiscal PolicyFiscal Policy

Automatic StabilizersAutomatic Stabilizers1.Welfare & food stamps1.Welfare & food stamps2. Unemploy. insurance2. Unemploy. insurance3. Social security3. Social security4. Corporate Dividends4. Corporate Dividends5. ProgressiveProgressive Tax System Tax System

Unempl. checkUnempl. check

Discretion of CongressDiscretion of Congress

Suppose the economy is inSuppose the economy is in recessionrecession::

Real GDPReal GDPTaxTax

collectionscollections

Transfer Transfer paymentspayments

GG > TTThe deficit growsThe deficit grows

Fiscal PolicyFiscal Policy Automatic stabilizersAutomatic stabilizers..

ASAS

ADAD22ADAD11

““Recession”Recession”YYRR Y*Y*

PLPL

If the economy If the economy has anhas an inflationaryinflationary gap gap::

TaxTaxcollectionscollections

Transfer Transfer paymentspayments

G G << TTThe surplus growsThe surplus grows

Fiscal PolicyFiscal Policy Automatic stabilizers.Automatic stabilizers.

Real GDPReal GDPASAS

““Inflationary Gap”Inflationary Gap”

ADAD22ADAD11

Y*Y* YYII

PL

Discretionary Fiscal PolicyDiscretionary Fiscal Policy

DiscretionaryDiscretionary

Expansionary Fis. PolicyExpansionary Fis. Policy1.1. Increase “G”Increase “G”2.2. Decrease “T”Decrease “T”

Contractionary Contractionary Fiscal PolicyFiscal Policy

1.1. Decrease “G”Decrease “G”2.2. Increase “T”Increase “T”

TThe he Kennedy/JohnsonKennedy/Johnson $ $1010 BillionBillion Tax Cuts Tax Cuts of of 19641964TheThe “Golden Age of Fiscal Policy”“Golden Age of Fiscal Policy”

When Kennedy came into officeWhen Kennedy came into office::1. T1. The he top marginal tax top marginal tax rate wasrate was 9191%%

&& drops to 52%drops to 52% [[35%35% today]today]2. T2. The he unemployment unemployment rate wasrate was 6.76.7%% & drops& drops belowbelow 5% 5%..3. A3. A recessionrecession becomesbecomes a very gooda very good low low unemployment - low unemployment - low inflation inflation (2%)(2%) economyeconomy..

4. The 4. The expansionexpansion continued to 1969continued to 1969..

Kennedy had been hesitant Kennedy had been hesitant about a $10 billion tax cut but about a $10 billion tax cut but finally saw the Keynesian Light.finally saw the Keynesian Light. 12/31-6512/31-65

Keynesian Policy: Keynesian Policy: ““Balance Balance the the Economy, Economy, not thenot the Budget Budget.”.”

DeficitsDeficits SurplusesSurpluses““Even if the jobsEven if the jobsareare digging holes digging holes and filling them upand filling them up.”.”

2. Just print the money2. Just print the money [Money creation – lower interest rates[Money creation – lower interest rates so this would be more expansionary]so this would be more expansionary]

FINANCING OFFINANCING OF DEFICITSDEFICITS [[IIss borrowingborrowing oror printing the moneyprinting the money more expansionary?]more expansionary?]

1. 1. Government borrows from theGovernment borrows from the public public [results in higher interest rates[results in higher interest rates which crowds out investment]which crowds out investment]

7%7%4%4%

MS1MS1 MS2MS2

ASASADAD22

YY** YY

But the LR increase in MS resultsBut the LR increase in MS results

in an in an increase in inflationincrease in inflationPLPL11

PLPL22 ADAD11

Lower Lower II.R..R.

HigherHigherI.R.I.R.

How To Dispose of SurplusesHow To Dispose of Surpluses[Should we[Should we hold the surplushold the surplus oror give it backgive it back]]

1. Debt Retirement 1. Debt Retirement [Give the surplus back during recessions to get lower interest rates and expand the economy]

ASASADAD22

Y*Y* YYII

2. Impound The Surplus2. Impound The Surplus [Keep the surplus during inflations and give it back during recessions]

PLPLADAD11

Rea

l in

tere

st r

ate

(%)

16

14

12

10

8

6

4

2

0

DDII

Investment (billions of dollars)

““CROWDING OUT” CROWDING OUT” EFFECT EFFECT [Incr G incr I.R. [Incr G incr I.R. Decr IgDecr Ig]]

5 10 1515 20 25 25 30 35 40

CrowdingCrowdingOutOut

EffectEffect

ASAS

ADAD11AD2AD2

44%%

22%%

YYRR

GG

IIGG

G can finance a deficit by:G can finance a deficit by:1. 1. Borrowing Borrowing - this raises interest rates in- this raises interest rates in the LFM and the LFM and “crowds out”“crowds out” investment. investment.2. 2. MoneyMoney Creation Creation - - no “crowding outno “crowding out” so is ” so is more expansionarymore expansionary than borrowing. than borrowing.

FriedmanFriedmanJust follow theJust follow the

““monetary rule.”monetary rule.”

YY**

Negative Net Export Effect of Fiscal PolicyNegative Net Export Effect of Fiscal Policy

YYRR Y*Y*

Expansionary Fiscal PolicyExpansionary Fiscal Policy

““Negative Xn”Negative Xn”

Due to higher interest rates, dollar appreciatesDue to higher interest rates, dollar appreciates

SRASSRAS

+Ig+Ig+C+C

-Xn-Xn

LRASLRAS

ADAD+G+GADAD

Negative Net Export Effect of Fiscal PolicyNegative Net Export Effect of Fiscal Policy

YYRR Y*Y*

DueDue to to lower interestlower interest

ratesrates, dollar depreciates, dollar depreciates

Expansionary Fiscal PolicyExpansionary Fiscal Policy

““Negative Xn”Negative Xn” ofof ““Negative Xn”Negative Xn” ofofContractionary Fiscal PolicyContractionary Fiscal Policy

DueDue to to higher interesthigher interest

ratesrates, dollar appreciates, dollar appreciates

SRASSRASSRASSRAS

+G+G +Ig+Ig+C+C

-Xn-Xn

-Ig-Ig -C-C

+Xn+Xn

Y*Y* YYII

LRASLRAS

LRASLRASADAD-G-G

LiberalLiberal (“ (“GG”)”) oror ConservativeConservative (“(“GG”)”)

LiberalsLiberalsRRecessionecession: Increase : Increase ““GG”;”; Inflation: Inflation: Increase “T”Increase “T”GG

GG ConservativesConservativesRecession: Recession: Decrease “T”; Decrease “T”; Inflation: Decrease “G”Inflation: Decrease “G”

Fiscal Policy LagsFiscal Policy Lags

“The shower starts out starts out too coldtoo cold, because the pipes have not yet warmed up. So the fool turns up the hot waterturns up the hot water. nothing happens, so he turns up the hotturns up the hot water furtherwater further. The hot water comes on and scalds himscalds him. He turns up the turns up the cold watercold water. Nothing happens right away, so he turns up turns up the cold furtherthe cold further. When the cold finally starts to come up, he finds the shower too coldtoo cold, and so it goes.”

Fiscal Policy lagsFiscal Policy lags1.1. Data (recognition) lagData (recognition) lag2.2. ““Wait-and-see” lag – short runWait-and-see” lag – short run3.3. Legislative lag (political)Legislative lag (political)4.4. Effect lag [takes months]Effect lag [takes months]

YYFFYYRR YYII

ADAD22ADAD11

LRASLRASSRASSRAS11

SRASSRAS22

EE44

EE44

EE22

EE11

EE22

EE33

Traditional Fiscal Policy [“G” & “T”]Traditional Fiscal Policy [“G” & “T”]will not work withwill not work with StagStagflationflation

ADAD11LRASLRAS

4%4%

55%%

1010%%

1010%%

YYRR

SRASSRAS22

StagStagflationflation

ADAD22

15%15%

1515%%

AD3AD3

YYFFYYRR

Was Reagan a “closet Keynesian”“closet Keynesian” with all the “G” & “T”?Perhaps he was a “Keynesian in drag.”“Keynesian in drag.”

0

100100

l

Tax revenue (dollars)Tax revenue (dollars)

Tax

rat

e (p

erce

nt)

Tax

rat

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erce

nt)

00

100100

m

l

Tax revenue (dollars)Tax revenue (dollars)

Ta

x ra

te (

%)

Ta

x ra

te (

%)

00

100100

mm

nn

l

Tax revenue (dollars)Tax revenue (dollars)

Tax

rat

e (p

erce

nt)

Tax

rat

e (p

erce

nt)

00

100100

m m

n

l

Tax revenue (dollars)Tax revenue (dollars)

Tax

rat

e (%

)T

ax r

ate

(%)

MaximumMaximumTaxTax

RevenueRevenue

Ben Stein [from “Ferris Bueler’s Day Off”] graduated from Ben Stein [from “Ferris Bueler’s Day Off”] graduated from Columbia University in 1966 with a degree in economicsColumbia University in 1966 with a degree in economics and from Yale Law School in 1970 as valedictorian. He and from Yale Law School in 1970 as valedictorian. He waswas

a speech writera speech writer for for Nixon. He Nixon. He has has written 16 books, written 16 books, including including

his latest humor book, “How To Ruin Your Life”.his latest humor book, “How To Ruin Your Life”.

Ben Stein’s part in this Ben Stein’s part in this movie as a boring econ movie as a boring econ prof was voted one of the prof was voted one of the 50 most famous scenes 50 most famous scenes in American film.in American film.

Tax rate (percent)Tax rate (percent)00 100100mm

mm

nl

Maximum Tax RevenueMaximum Tax Revenue

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 hittingthe top marginal tax rate of 90%. After 4, because he could only keep 10%,he would quit making movies until the next year.

““Yes, I was on the Yes, I was on the Laffer cuve. I Laffer cuve. I couldn’t couldn’t

shoot my way out”shoot my way out”

The “Gipper”The “Gipper”BonzoBonzo

For rich peoplerich people, there would be a disincentive to quitdisincentive to quit workingworking when they hit the top marginal tax rate. For most workersmost workers, this was not the casenot the case.

RReaganeagan

Tax

rev

enu

e T

ax r

even

ue

(do

llar

s)(d

oll

ars)

EEmphasismphasis on on EExpansionary xpansionary Tax CutsTax Cuts[which shifts AD to the right, increasing Y & PL]

Impact uponImpact upon......

•Saving and InvestmentSaving and Investment [Lower taxes increase DI & S; less business taxes will

increase investment. Our “national factory” will increase.]

• Work IncentivesWork Incentives [Keeping more of our money makes us work harder and longer]

• Risk TakingRisk Taking [Lower tax rates promise a larger potential after-tax reward]

So, the AS Curve will shift right bringing prices downAS Curve will shift right bringing prices down..

We will haveWe will haveEconomic Economic

Heaven.Heaven.

SUPPLY-SIDE FISCAL POLICYSUPPLY-SIDE FISCAL POLICY

0

Pri

ce le

vel

Pri

ce le

vel

Real GDPReal GDP

ADAD11ADAD22 ASAS11 ASAS22

PLPL11

PLPL22

PLPL33

QQ11 QQ22 QQ33

Can sustain a much greater increase in AD if the Can sustain a much greater increase in AD if the AS curve is also shifting to the right.AS curve is also shifting to the right.

1010%%

1010%%

Pri

ce L

evel

Pri

ce L

evel

ASAS

ADAD22

Inflation and the MultiplierInflation and the Multiplier [4] [4]

GDPGDP11 GDPGDP22

MULTIPLIER WITH PRICE-LEVEL CHANGESMULTIPLIER WITH PRICE-LEVEL CHANGES

PP11

AD1

ADAD33

GDPGDP33

PP22

Full Multiplier EffectFull Multiplier EffectReducedReducedMultiplierMultiplierEffect DueEffect Dueto Inflationto Inflation

+20+20

+ 80 bil.+ 80 bil.

+20+20

+ 40 + 40 bil.bil.

M(4)=chg.Y/chg.EM(4)=chg.Y/chg.E [80] [20][80] [20]

M(2)=chg.Y/chg. EM(2)=chg.Y/chg. E [40] [20][40] [20]

Pri

ce l

evel

Pri

ce l

evel

Real GDP (billions)Real GDP (billions)

EXPANSIONARY FISCAL POLICYEXPANSIONARY FISCAL POLICY

Full $20 billionFull $20 billionincrease in ADincrease in AD

ADAD11 ADAD22

$5 billion $5 billion initial direct increase in spendinginitial direct increase in spending

[MPS=.25MPS=.25] the multiplier at work...

PP11

$485$485

+5+5

ASAS

$505$505

Pri

ce le

vel

Pri

ce le

vel

Real GDP (billions)Real GDP (billions)

CONTRACTIONARY FISCAL POLICYCONTRACTIONARY FISCAL POLICY[MPS=.25MPS=.25] the multiplier at work...

PP22

$515$515

Full $20 billionFull $20 billiondecrease in ADdecrease in AD

ADAD11ADAD22

$5 billion initial$5 billion initialdirect decrease in direct decrease in

spendingspending

PP11

ASAS

LEGISLATIVE MANDATESLEGISLATIVE MANDATESEmployment Act of 1946Employment Act of 1946

Council of Economic Council of Economic Advisors(CEA)Advisors(CEA)

Joint Economic Committee (JEC)Joint Economic Committee (JEC)

Legislative Mandates for Remedial Fiscal MeasuresLegislative Mandates for Remedial Fiscal Measures

1. Employment Act of 1946Employment Act of 1946 – a law promoting economic stability (by promoting “maximum employment, production“maximum employment, production, and , and purchasing powerpurchasing power””) through monetary and fiscal policiesmonetary and fiscal policies. This act was a government commitmentgovernment commitment to ensure prosperity after WWII. [not only “could”“could” but “would”“would” – no more laissez faire] This act gave the Keynesians economistsKeynesians economists the theoretical and legal justificationlegal justification to use fiscal policyuse fiscal policy to stabilize the economy.

2. Council of Economic Advisers (CEA)Council of Economic Advisers (CEA) [for the PresidentPresident] – 3 distinguished economists3 distinguished economists (on leave from

universities) who assist and advise the Presidentassist and advise the President on economic matters. Their staff is made up of 11 senior and 6 junior economists. They forecast and project the deficit, inflation, GDP growth, deficit, inflation, GDP growth, foreign exchange rates, immigration, foreign exchange rates, immigration, & & antitrust legislationantitrust legislation. The President must submit an annual economic report describing the current economic state with recommendations.““TThe he President’s intelligencePresident’s intelligence arm arm in the warin the war against the against the business cycle.” business cycle.”

Head Head of theof the CEA CEA

Greg MankiwGreg Mankiw of Harvard has ridiculed of Harvard has ridiculed

supply-side tax cuts assupply-side tax cuts as “fad economics”“fad economics” conceived byconceived by ““charlatanscharlatans and cranks,” and cranks,” in his textbook.in his textbook.

Ben BernankeBen Bernanke,, FFormer ormer BBoard oard GGovernor,overnor, succeeded Maniew. succeeded Maniew. [scored 1590 on SAT][scored 1590 on SAT][Now Chairman of Fed][Now Chairman of Fed]

Edward LazearEdward LazearPHD PHD in in Econ, HarvardEcon, Harvard

Katherine BaickerKatherine BaickerU.C.L.A.U.C.L.A.

MattMattSSlaughterlaughter

of of DDartmouthartmouth

Joint Economic Committee of CongressJoint Economic Committee of Congressand Humphrey-Hawkins Act of 1978and Humphrey-Hawkins Act of 1978

3. J oint Economic Committee(J EC) of Congress – an advisory group or intelligence arm in the war against contractions in the business cycle. After gathering and analyzing economic data, they make forecasts and formulate programs to improve employment.

4. Humphrey-Hawkins Act of 1978 – (Full Employment & Balanced Growth Act) - requires the government to establish 5-year economic goals and formulate plans to achieve it. The goals were to seek 4% unemployment and zero inflation. If you look at my “C” If you look at my “C”

average college grades, average college grades, the CEA can help me.the CEA can help me.

AE AE & & Fiscal Policy QFiscal Policy Questions on uestions on 2000 AP E2000 AP Examxam

1. (81%) The value of the spending multipliervalue of the spending multiplier (ME) decreases when a. tax rates are reduced d. government spending increases b. exports decline e. the marginal propensity to save increases c. imports decline2. (75%) Which of the following policies would a Keynesian recommendKeynesian recommend during a period of high unemployment and low inflationhigh unemployment and low inflation? a. decreasing the MS to reduce AD b. decreasing taxes to stimulate AD c. decreasing government spending to stimulate AS d. balancing the budget to stimulate AS3. (47%) Which of the following best explains why equilibrium income willequilibrium income will increase by more than $100 in response to a $100 increase inincrease by more than $100 in response to a $100 increase in GG? a. Incomes will rise, resulting in a tax decrease. b. Incomes will rise, resulting in higher consumption. c. The increased spending raises the aggregate price level. d. The increased spending increases the money supply, lowering interest rates. e. The higher budget deficit reduces investment.4. (56%) Unexpected increases in inventoriesUnexpected increases in inventories usually precede a. increases in inflation b. increases in imports c. stagflation d. decreases in production e. decreases in unemployment

If MPS incr from .10 to .20, the If MPS incr from .10 to .20, the MMEE would decrease from 10 to 5. would decrease from 10 to 5.

The Multiplier ensures more Cmore Cwith each round.

5. (63%) The economy on the right iseconomy on the right is currently experiencingexperiencing a. inflation b. recession c. expansion d. stagflation e. rapid growth6. (77%) Correct monetary policymonetary policy to reach FE GDPreach FE GDP is to increase increase a. the MS b. the RR c. discount rate d. taxes e. exports7. (36%) The minimum increase in governmentminimum increase in government spendingspending to reach full employment reach full employment is a. $2,000 b. $1,000 c. $500 d. $200 e. $100

8. (58%) In the simple Keynesian AE modelsimple Keynesian AE model [not AD/AS][not AD/AS] of an economy, changes changes in in Ig or G Ig or G will lead to a change in whichlead to a change in which of the following? a. the price level b. the level of output and employment c. interest rates d. the AS curve 9. (83%) In a closed-privateclosed-private in which the APC is .75APC is .75, which of following is truetrue? a. If income is $100, then saving is $75. d. If income is $200, then “C” is $75 b. If income is $100, then “C” is $50 e. If income is $500, then saving is $100 c. If income is $200, then saving is $50

45°45° Fu

ll.E

mp

loy.

Fu

ll.E

mp

loy. CC

C+IgC+Ig

AEAE

$$500500

$400$400

0 0 $800$800 $1,000 $1,000 $2,000$2,000

SS

EE

AA

Determine what the “M” is goingfrom A to E; then M X ? = $1,000

10. (63%) Suppose that DI is $1,000DI is $1,000, consumption is $700consumption is $700, and the MPC is .6MPC is .6. If DI then increases by $100DI then increases by $100, consumption and savings will equal which of the following? ConsumptionConsumption SavingsSavings a. $420 $280 b. $600 $400 c. $660 $320 d. $660 $440 e. $760 $340

Fiscal Policy Questions from 2000 ExamFiscal Policy Questions from 2000 Exam

11. (73%) An inflationary gapinflationary gap can be eliminatedcan be eliminated by all of the following EXCEPTEXCEPT a. an increase in personal income taxes d. a decrease in G b. an increase in the MS e. a decrease in Xn c. an increase in the interest rate12. (56%) A major advantage of automatic stabilizersadvantage of automatic stabilizers in fiscal policy is that they a. reduce the public debt b. increase the possibility of a balanced budget c. stabilize the unemployment rate d. go into effect without passage of new legislation e. automatically reduce the inflation rate

If If $700 of $1,000 DI is consumed$700 of $1,000 DI is consumed, then , then saving is $300saving is $300. . MPC of .6MPC of .6 means if DI means if DI increases by $100, then increases by $100, then $60 more will be $60 more will be consumedconsumed & & $40(.4) $40(.4) more will be savedmore will be saved(40%).(40%).The The $60 $60 added to theadded to the $700 $700 already consumedalready consumed= $760= $760 consumedconsumed and the and the additional $40 additional $40 saved = $340 savedsaved = $340 saved..

Which answer doesWhich answer doesnot slow the economy?not slow the economy?

13. (70%) In the short run, a contractionary fiscal policycontractionary fiscal policy will cause ADAD, outputoutput, and the price levelprice level to change in which of the following ways?

ADAD OutputOutput Price levelPrice level a. decrease decrease decrease b. decrease increase increase c. increase decrease decrease d. increase increase increase 14. (52%) Crowding outCrowding out due to government borrowing occurs when a. lower interest rates increase private sector investment b. lower interest rates decrease private sector investment c. higher interest rates decrease private sector investment d. a smaller money supply increases private sector investment 15. (41%) If, at FE, the G wants to increase its spending by $100 billionG wants to increase its spending by $100 billion without increasing inflation in the short run, it must do which of the following? a. raise taxes by more than $100 billion c. raise taxes by less than $100 b. raise taxes by $100 billion d. lower taxes by $100 billion16. (42%) Compared to expansionary monetary policiesexpansionary monetary policies adopted to counteract a recession, expansionary fiscal policiesexpansionary fiscal policies tend to result in a. less public spending c. a high rate of economic growth b. higher interest rates d. lower prices

1995 AP Exam1995 AP Exam

17. (71%) An increase inincrease in which will increase the value of the Mincrease the value of the MEE? a. The supply of money d. The marginal propensity to consume b. Equilibrium output e. The required reserve ratio c. Personal income tax rates

18. (61%) An AS curve may be horizontal over some rangeAS curve may be horizontal over some range because within that range a. a higher PL leads to higher interest rates, which reduces the MS & “C” b. changes in the aggregate PL do not induce substitution c. output cannot be increased unless prices and interest rates increase d. rigid prices prevent employment from fluctuating e. resources are underemployed & an increase in AD will be satisfied without any pressure on the PL

19. (45%) What could cause simultaneous increases in inflation & unemploymentcause simultaneous increases in inflation & unemployment a. a decrease in government spending d. An increase in inflationary expectations b. A decrease in the money supply e. An increase in productivity c. A decrease in the velocity of money20. (85%) Which of the following will result in the greatest increase in ADgreatest increase in AD? a. A $100 increase in taxes b. A $100 decrease in taxes c. A $100 increase in government expenditures d. A $100 increase in government expenditures, coupled with a $100 increase in taxes e. A $100 increase in government expenditures, couples with a $100 decrease in taxes21. (65%) Which of the following will result from a decrease in government spendingdecrease in government spending? a. An increase in output d. A decrease in AS b. An increase in the price level e. A decrease in AD c. An increase in employment

23. (48%) If private investment of $100 is addedprivate investment of $100 is added to the economy, the equilibrium levels of incomeincome andand consumption consumption will changewill change in which of the following ways? Equil. LevelEquil. Level Equil. LevelEquil. Level of Incomeof Income of Consumptionof Consumption a. Increasea. Increase DecreaseDecrease b. Increaseb. Increase IncreaseIncrease c. Increasec. Increase No changeNo change d. No changed. No change IncreaseIncrease e. No changee. No change No changeNo change

45°45°

CC

Exp

end

itu

res

Exp

end

itu

res

$700$700

0 0 $1,500$1,500 $2,000$2,000 Real IncomeReal Income

SSQuestions 22-23 refer to the diagram(rt),Questions 22-23 refer to the diagram(rt),which depicts an economy’s “C” function.which depicts an economy’s “C” function.

22. (56%) If the MPC increasesMPC increases, the equilibriumequilibrium levels of levels of incomeincome and and consumption consumption will will changechange in which of the following ways? Equil. LevelEquil. Level Equil. LevelEquil. Level of Incomeof Income of Consumptionof Consumption a. No changea. No change No change No change b. No changeb. No change Increase Increase c. Increasec. Increase No change No change d. Increased. Increase Increase Increase e. Decrease Decrease e. Decrease Decrease

A larger MPC means a smaller MPS, and a larger M. this will increase incomeincrease income and result in more “C”more “C” atthe new level of equilibrium income (GDP).

C+IgC+Ig

+ $100 Ig+ $100 Ig

CC11

CC22

45°45°

C+IgC+IgC+Ig+GC+Ig+GAEAE

$300$300$200$200

0 0 $1,000$1,000 $1,500$1,500 GDP

EE

FF22. (61%) The graph indicates equilibrium at Eequilibrium at E for a closed economyclosed economy without G. If the additionaddition of of G resultsG results in in equilibrium equilibrium atat FF, which of the following is true? a. G is $300 and the multiplier is 5.b. G is $100 and the multiplier is 5.c. G is $100 and consumption increased by $500.d. G and Ig increase by $500.e. Consumption and GDP increase by $500 each.

23. (84%) According to Keynesian theoryKeynesian theory, decreasing taxes and increasing Gdecreasing taxes and increasing G will most likely change consumptionchange consumption and unemploymentunemployment in which of the following ways? ConsumptionConsumption UnemploymentUnemployment a. Decrease No change b. Decrease No change c. Increase Decrease d. Increase Increase e. No change Decrease24. (79%) In an economy at full employmenteconomy at full employment, a presidential candidate proposes cutting the government debt in half in 4 years by increase T and reducing Gincrease T and reducing G. According to Keynesian theoryKeynesian theory, implementation of these policies is most likely to increaseincrease a. unemployment d. aggregate supply b. consumer prices e. the rate of economic growth c. aggregate demand

25. (79%) If the economy is in a severe recessionsevere recession, which of the following is the fiscal policyfiscal policy most effective inmost effective in stimulating production and employmentstimulating production and employment? a. Government spending increases. b. Government spending decreases. c. Personal income taxes are increased. d. The Fed sells bonds on the open market. e. The Fed buys bonds on the open market.

26. (27%) Faced with a large federal budget deficit, the government decides to decreasedecrease expenditures expenditures and tax revenuestax revenues by the same amountby the same amount. This action will affectaffect outputoutput and interest ratesinterest rates in which of the following ways? OutputOutput Interest RatesInterest Rates a. Increase Increase b. Increase Decrease c. No change Decrease d. Decrease Increase e. Decrease Decrease

27. (28%) If crowding outcrowding out only partially partially offsets the effects of a tax cuteffects of a tax cut, which of the following changeschanges in interest ratesinterest rates and GDPGDP are most likely to occur. IInterest nterest RRatesates GDPGDP a. Increase Increase b. Increase Remain unchanged c. Increase Decrease d. Remain unchanged Increase e. Decrease Decrease

An equal decrease in G & T [Let’s say by $10 billion] woulddecrease GDP by $10 billiondecrease GDP by $10 billion. The decrease in GDP woulddecrease PL which would cause a decrease in interest ratesdecrease in interest rates.

PartiallyPartially means GDP increasesGDP increases. Starting from a balanced budget, the tax cut would put the G in deficitand the G borrowing would increase demand for moneyin the LFM and push up interest ratespush up interest rates.

28. (62%) According to the Keynesian saving scheduleKeynesian saving schedule, when aggregate income increasesaggregate income increases by a given amount, savingssavings will will a. remain the same b. decrease by the amount of the change in income c. increase by the amount of the change in income d. increase by less than the amount of the change in income e. increase by more than the amount of the change in income

President Bush’s College TranscriptPresident Bush’s College Transcript

And – What did President Bush have And – What did President Bush have to say about to say about “power pants”?“power pants”?

1. With the Employment Act of 1946Employment Act of 1946, the federal government committed itself to accept (total/some) degree of responsibility for employment/prices.2. Fiscal policyFiscal policy is carried out primarily by the (local/state/federal) government.3. Discretionary fiscal policyDiscretionary fiscal policy [G & T] (does/does not) require congressional action.4. In a mixedmixed [private & public) closed economyclosed economy, taxes & (savings/government spending) are leakagesleakages, while Ig and (savings/government spending) are injectionsinjections.5. In a mixedmixed economyeconomy, the equilibrium GDP exists where (C+Ig/C+Ig+G+Xn)=GDP.6. The balanced budget multiplierbalanced 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 billionequilibrium GDP is $400 billion & the MPC is .80. Suppose the G collects new taxes of $50 bil.G collects new taxes of $50 bil. & spends the entire amountspends the entire amount on our infrastructure. As a result equilibrium GDP will be ($400/$450/$500) bil.

8. Suppose a constitutional amendmentconstitutional amendment requires that the G always balanceG always balance its budgetits budget. If it desired to increase GDP by $40 billionincrease GDP by $40 billion, G should (increase/decrease) government spending & taxes by ($30/$40/$50) billion.

12. If the F.E. GDP is OCF.E. GDP is OC, then it would be appropriate fiscal policy for government to (increase/decrease) “G”“G” and (increase/decrease) “T”“T”.

13. If the F.E. GDP is OAF.E. GDP is OA, then it would be appropriate fiscal policy for government to (increase/decrease) “G”“G” and (increase/decrease) “T”“T”.

10. If the government tries to eliminate a budget deficit during a depressioneliminate a budget deficit during a depression, these efforts will (help/hurt) the depression.

11. A conservative economistconservative economist who advocates an active fiscal policy

would recommend taxtax (increases/decreases) during a recessionrecession and

(increases/decreases) in government spendinggovernment spending during inflationinflation.

9. In a severe recessionsevere recession, Keynesians would favor a(n) (increase/decrease) in taxes.

YYIICC AA

AEAE11

AEAE22PLPL

YYR R Y*Y*800 800 ??

AEAEPLPL

OO YYRR

SS

14. If G increases its spending during a recessionduring 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 expansionarymost expansionary.

15. The following fiscal actionsfiscal actions, (incurring a budget surplusand 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 inflationcurbing inflation.

16. The greatest anti-inflationary impact of a budgetgreatest anti-inflationary impact of a budget surplussurplus will occur when the G (impounds/uses) the surplus funds & lets them (stand idle/pay off the debt).

17. In describing the built-in stabilizersbuilt-in stabilizers, we can say that

personal personal && corporate income tax collections corporate income tax collectionsautomatically (incr/decr) as as GDP increasesGDP increases & transfers transfers & subsidies& subsidies (incr/decr) as as GDP increasesGDP increases.

Should I Should I give it back?give it back?

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

Recognition LagRecognition Lag Action LagAction Lag Effect LagEffect Lag

FISCAL POLICY – Pure and SimpleFISCAL POLICY – Pure and Simple

Fiscal Policy:Fiscal Policy:No ComplicationsNo Complications

Pri

ce le

vel

Real GDP (billions)Real GDP (billions)

ADAD11ADAD22

PP11

$490 $490 YRYR

ASAS

There are 3 things that could “diminish AD.”“diminish AD.”

$510$510Y*Y*

Crowding-out EffectCrowding-out EffectHigher interest rHigher interest ratesates

ddecrease ecrease investment]investment]and the . . .and the . . .

Real GDP (billions)

ADAD11 ADAD22

PLPL11

$490$490 $510$510

ASASAD’AD’22

$503$503

Three things that could “diminish AD.”Three things that could “diminish AD.”1.1. Crowding-out EffectCrowding-out Effect 2.2. Net Export EffectNet Export Effect

Net Export EffectNet Export EffectExpansionary fiscal policyExpansionary fiscal policyleads to more governmentleads to more governmentborrowing, increasing theborrowing, increasing theinterest rate,interest rate, & & decreasingdecreasing Ig Ig

3. Inflation would be a third factor 3. Inflation would be a third factor That couldThat could reduce aggregate demand reduce aggregate demand

Pri

ce level

Real GDP (billions)

ASADAD22

$$495495 $515

PP11

AD1

$$505505

Answer the next 3 questions(18-21) based on the diagram.18. DeficitsDeficits will be realized at GDP levels (below/above) C, and surplusessurpluses (below/above) C.19. If the F.E. GDP for the economy is at DD, the F.E. budgetF.E. budget will entail a (deficit/surplus).20. If the tax line had a greater slopetax line had a greater slope [more progressive tax system], stabilitystability would be (less/greater).21. If government adhered strictly to an annually balanced budgetadhered strictly to an annually balanced budget then the government’s budget would tend to (destabilize/stabilize) the economy.

T2

NS 18-21NS 18-21

11

NSNS 22-3022-30For Questions 22-24 [graph]22. (T1/T4) tax system is characterized by the least built-in stabilityleast built-in stability.23. (T1/T4) tax system is characterized by the most built-in stabilitymost built-in stability.24. (T1/T4) tax system will generate the largest cyclical deficitslargest cyclical deficits.25. NondiscretionaryNondiscretionary Fiscal Policy (does/does not) require congressional action.

26. If the MPC is .5, a $10 B increase in “G”$10 B increase in “G” will increase “Cincrease “C”” [not incomenot 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 surplusgovernment tries to give back a surplus during an inflationaryduring an inflationary FE yearFE year, this will be (pro-cyclical/counter-cyclical). 28. When politicians use fiscal policy to cause an improvementimprovement in the economy just prior to an electionin the economy just prior to an election, this is called a (presidential/Congressional/political) business cycle.29. When G incurs a deficit which is financed by borrowingG incurs a deficit which is financed by borrowing, causing interest rates to increase which decreases Iginterest rates to increase which decreases Ig, this is called the (crowding-in/crowding out) effect.30. Supply-sidersSupply-siders argue that the primary effect of tax cutsprimary effect of tax cuts is to shift the AS curve (leftward/rightward).

34. If the MPS is .2MPS is .2 and the economy has a

recessionary spending gap of $5recessionary spending gap of $5 billionbillion, we may conclude that the equilibriumequilibrium levellevel of of GDPGDP is ($5/$20/$25) below the FE GDP.

33. In a private-closed economy, the MPS is .2MPS is .2,

consumption equals income at $200 consumption equals income at $200 billionbillion, and the level of investmentinvestment is is $10 $10 billionbillion. The equilibrium level of income at the new level is ($200/$250) billion.

31. If the MPC is .8MPC is .8, a $2 billion increase in “G”$2 billion increase in “G” will increase

““consumption”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 .9MPC is .9, a $1 billion increase in “G”$1 billion increase in “G” will increase ““consumption”consumption” by ($10/$9/$8) billion.

NS 31-34NS 31-34

45°45°

45°45°

C+IgC+Ig

200200

200200 ??

““C”C”

+$10 Ig+$10 Ig

AEAE

AE1AE1

AE2AE2

YYR R ??

AEAE

+$5+$5

SS

SS

36. If the government decreases G&T by $10 billiongovernment decreases G&T by $10 billion, then a

MPS of .10MPS of .10, the equilibrium GDPequilibrium GDP would (increase/decrease) by ($5/$10/$100) billion.

37. With a MPC of .75MPC of .75, Government increases G&T by $8Government increases G&T by $8 billionbillion.

The equilibrium GDPequilibrium GDP (increases/decreases) by ($75/$32/$8) billion.

38. If the government runs a budget surplus and desires to government runs a budget surplus and desires to curb inflationcurb inflation, it should (give the surplus back/keep it in storage).

35. If the MPS is .5MPS is .5 and the economy has an

inflationaryinflationary spending gap of $6 spending gap of $6 billionbillion, we may conclude that the equilibrium level equilibrium level of GDPof GDP is ($6/$12/$18) billion above the FE GDP.

NS 35 - 38NS 35 - 38

-$6-$6

45°45°

AE1AE1

AE2AE2

Y*Y* YYII

AEAESS

1. Expansionary Expansionary fiscal policyfiscal policy will be most effective [increase GDP] when the ASAS curve is curve is (vertical/horizontal)

& (incr/decr) “C” and (incr/decr) unemployment.

2. The paradox of thriftparadox of thrift indicates that an increase in saving (matched/ unmatched) by an increase in investment will lower equilibrium GDP.

3. A contractionary fiscal policycontractionary fiscal policy [decr Gdecr G, , incr Tincr T] would cause a[an] (incr/decr) in output[GDP] and a[an] (incr/decr) in interest rates. An expansionary fiscal policyexpansionary fiscal policy [incr Gincr G, , decr Tdecr T] would cause a[an] (incr/decr) in output[GDP] and a[an] (incr/decr) in interest rates.

4. In the AE model, if AE[AD]doesn’t buy up FE output(GDP)AE[AD]doesn’t buy up FE output(GDP), then the equilibrium output is (less than/more then) full employment output.

[G ; LFM ; In. Rates ][G ; LFM ; In. Rates ]

[G ; LFM ; In. Rates ][G ; LFM ; In. Rates ]

G G $2 Tr.$2 Tr. T T $2 Tr$2 Tr..[On #3, start froma balanced budget]

““Recessionary Gap”Recessionary Gap” ““Inflationary Gap”Inflationary Gap”

5. To decrease AD the greatest amountdecrease 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 recessionaryrecessionary gapgap (AE model) at the equilibrium point[actualequilibrium point[actual GDP]GDP] planned investmentplanned investment is (greater than/equal to/less than) savingsaving,, but at the FEFE GDP levelGDP level, planned investment[backup] is (greater than/equal to/less than) savingsaving.8. In an inflationaryinflationary gapgap(AE modelAE 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 inventoriesunplanned increase in inventories, AE is (less than/greater than) FE output & spendingFE output & spending will (increase/decrease).10. If businesses are experiencing an unplanned decrease in inventoresunplanned decrease in inventores [disinvestmentdisinvestment] AE is (less than/greater than) FE output & spendingFE output & spending will (increase/decrease).

11. If “C” equals income at $500 billion“C” equals income at $500 billion, & MPC is .9MPC is .9, then an increase in Ig of $10 billion will change equilibrium GDP to ($400/$490/$510/$600) billion.12. A conservative conservative economisteconomist would want tax (incr/decr) during a recessionrecession & (incr/decr) in “G” during inflationary timesinflationary times.13. A liberal economistliberal economist would want tax (incr/decr) during an inflationinflation & (incr/decr) in “G” during recessionary periodsrecessionary periods.14. An inflationary gapinflationary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP.

15. A recessionary gaprecessionary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP.

16. To increase GDP[but reduce military spending]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 economytax cut to expand the economy would (incr/decr) Y & (incr/decr) in. rates.18. A tax increase to contract the economytax increase to contract the economy would (incr/decr) Y & (incr/decr) IR.

500500

500500

19. To increase equilibrium GDP by increase equilibrium GDP by $400,000$400,000, with a MPC of .5, a Keynesian economist would (decrease “T”/increase “G”) by $200,000.

20. Assume equilibrium GDP is equilibrium GDP is $500$500 billion billion & MPS is .4. Now “G” collects taxes of of “G” collects taxes of of $22$22 billion and spends billion and spends the entire amountthe entire amount. As a result, equilibrium GDP will change to: ($445/$478/$522/$555).21. With a MPC of .5MPC of .5, a $12 billion$12 billion increase in “G” will increaseincrease “C” “C” by ($12/$24/$36) bil.

22. With a MPC of .5MPC of .5 and the economy in a recessionaryrecessionary spending gapspending gap of of $$1212 billion billion, we may conclude that the equilibrium is ($12/$24/$36) billion short of FE GDPshort of FE GDP.

23. An increase in Ig of $25 increase in Ig of $25 billionbillion results in an increase in equilibrium income(GDP) of $50B, so the MPS is?24. A contractionary fiscal policycontractionary fiscal policy results in a(n) (incr/decr)

in output, and a(n) (incr/decr) in interest rates.

25. Increasing T or decreasing GIncreasing T or decreasing G will (increase/decrease) consumption, and (increase/decrease) unemployment.

26. With a MPC of .5.5, and the economy with an inflationaryinflationary GDP GDP GapGap of $50B, G could eliminate this inflationaryinflationary GDP GapGDP Gap by reducing government spendingreducing government spending by?

27. With a MPC of MPC of .5.5 and current output at $500 bil. but FEcurrent output at $500 bil. but FE output is $700 biloutput is $700 bil., correct fiscal policycorrect fiscal policy would be to

(increase G/decrease T) by $100 billion.

[Incr T or Decr G][Incr T or Decr G]

.5.5

$25 bil.$25 bil.

28. An increase in Igincrease in Ig in an economy (increase)/decrease) GDP & (increase/decrease) C.

29. In a recessionary economyrecessionary economy, at FEFE GDPGDP, savingsaving is (less than/more than) IgIg. 30. In a recessionary economyrecessionary economy, (actual Y/potential Y) exceeds (actual Y/potential Y). 31. In a mixed-closed economymixed-closed economy (no Xnno Xn), the leakagesleakages are? and the injectionsinjections are?32. If the economy has an inflationary Gapinflationary Gap, at

FE GDPFE GDP, savingsaving (exceeds/is less than) Ig.

33. If there is an equal increase inequal increase in GG&&T T of of $25 $25 bilbil., then outputoutput will (increase/decrease) & interest ratesinterest rates [based on PL][based on PL] will (increase/decrease).

[S & T][S & T] [G & Ig][G & Ig]

The EndThe End

E-conE-conE-conE-con

Review for Review for AE AE && Fiscal Policy Fiscal Policy

““Econ, econ”Econ, econ”