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    Macroeconomics Ch.12 Flashcards

    Study with Quizlet and memorize flashcards terms like Reductions in personal income tax rates that increase labor supply and work effort, can be expected to also a. decrease consumption spending. b. increase consumption spending. c. decrease investment spending. d. increase export sales., According to the Keynesian view, the proper response to a severe recession would be a. reliance on automatic stabilizers to direct the economy toward full employment. b. a shift toward a restrictive monetary policy to reduce aggregate demand. c. an increase in taxes in order to reduce the budget deficit. d. an increase in government spending financed by borrowing., In a world where capital moves rapidly across national boundaries, if a larger budget deficit leads to higher real interest rates, a. there will be an inflow of foreign capital, which will cause the dollar to depreciate and net exports to increase. b. there will be an inflow of foreign capital, which will cause the dollar to appreciate and net exports to decline. c. there will be an outflow of foreign capital, which will cause the dollar to depreciate and net exports to increase. d. there will be an outflow of foreign capital, which will cause the dollar to appreciate and net exports to decline. and more.

    Macroeconomics Ch.12

    Reductions in personal income tax rates that increase labor supply and work effort, can be expected to also

    a. decrease consumption spending.

    b. increase consumption spending.

    c. decrease investment spending.

    d. increase export sales.

    Click card to see definition 👆

    ANSWER: B

    increase consumption spending.

    Click again to see term 👆

    According to the Keynesian view, the proper response to a severe recession would be

    a. reliance on automatic stabilizers to direct the economy toward full employment.

    b. a shift toward a restrictive monetary policy to reduce aggregate demand.

    c. an increase in taxes in order to reduce the budget deficit.

    d. an increase in government spending financed by borrowing.

    Click card to see definition 👆

    ANSWER: D

    an increase in government spending financed by borrowing.

    Click again to see term 👆

    1/30 Created by becca-lynn_thiel3

    Terms in this set (30)

    Reductions in personal income tax rates that increase labor supply and work effort, can be expected to also

    a. decrease consumption spending.

    b. increase consumption spending.

    c. decrease investment spending.

    d. increase export sales.

    ANSWER: B

    increase consumption spending.

    According to the Keynesian view, the proper response to a severe recession would be

    a. reliance on automatic stabilizers to direct the economy toward full employment.

    b. a shift toward a restrictive monetary policy to reduce aggregate demand.

    c. an increase in taxes in order to reduce the budget deficit.

    d. an increase in government spending financed by borrowing.

    ANSWER: D

    an increase in government spending financed by borrowing.

    In a world where capital moves rapidly across national boundaries, if a larger budget deficit leads to higher real interest rates,

    a. there will be an inflow of foreign capital, which will cause the dollar to depreciate and net exports to increase.

    b. there will be an inflow of foreign capital, which will cause the dollar to appreciate and net exports to decline.

    c. there will be an outflow of foreign capital, which will cause the dollar to depreciate and net exports to increase.

    d. there will be an outflow of foreign capital, which will cause the dollar to appreciate and net exports to decline.

    ANSWER: B

    there will be an inflow of foreign capital, which will cause the dollar to appreciate and net exports to decline

    Which one of the following is an area of agreement among modern macroeconomists with regard to the use of fiscal policy?

    a. Congressional action is necessary if automatic stabilizers are going to be an effective stabilization tool.

    b. Fiscal policy is more potent than the early Keynesian view implied.

    c. It is difficult to time changes in discretionary fiscal policy in a manner that will promote stability.

    d. Budget deficits are a highly effective tool with which to combat a severe recession.

    ANSWER: C

    It is difficult to time changes in discretionary fiscal policy in a manner that will promote stability.

    Within the framework of the AD-AS model, an increase in savings by households will

    a. be offset by a decrease in savings by businesses.

    b. increase the supply of loanable funds and reduce interest rates.

    c. cause long-run fluctuations in the rate of consumption.

    d. result in a decline in aggregate demand, output, and employment.

    ANSWER: B

    increase the supply of loanable funds and reduce interest rates.

    Refer to Figure 12-2. Which of the following will most likely be favored by a new classical economist if the economy is operating at point a?

    a. continuation of the current tax and expenditure policies (dependence on the economy's self-correcting mechanism to restore full employment)

    b. a tax increase to balance the budget

    c. restrictive fiscal policy

    d. expansionary fiscal policy

    ANSWER: A

    continuation of the current tax and expenditure policies (dependence on the economy's self-correcting mechanism to restore full employment)

    According to new classical economists, the most appropriate policy during a recession would be for the government to

    a. cut taxes and increase the budget deficit.

    b. impose wage and price controls.

    c. increase the minimum wage.

    d. do nothing. ANSWER: D do nothing.

    It will be difficult to institute fiscal policy in a stabilizing manner because politicians will find

    a. it attractive to increase taxes during a recession, but they will be reluctant to reduce them during an expansion.

    b. it more attractive to raise taxes than to increase spending.

    c. budget surpluses attractive during a recession, but they will be reluctant to run budget deficits during an expansion.

    d. budget deficits attractive during a recession, but they will be reluctant to run budget surpluses during an expansion.

    ANSWER: D

    budget deficits attractive during a recession, but they will be reluctant to run budget surpluses during an expansion.

    Which of the following most clearly indicates that fiscal policy is becoming more expansionary?

    a. A reduction in the budget deficit relative to GDP

    b. An increase in the nominal (dollar) size of the budget deficit

    Source : quizlet.com

    3 Cyclicality of Fiscal Policy in: Promoting Fiscal Discipline

    Abstract Although some debate on the feasibility and effectiveness of fiscal policy in stabilizing output fluctuations continues, there is little disagreement that, as a rule, policy should not be procyclical. The standard Keynesian approach suggests that fiscal policy should act in a stabilizing manner, while within the neoclassical paradigm, tax-smoothing models imply that fiscal policy should remain neutral over the business cycle. Even in a Ricardian framework, where a reduction in taxes or an increase in spending leads to an equivalent rise in private sector saving, policy would not be expected to be procyclical.

    Although some debate on the feasibility and effectiveness of fiscal policy in stabilizing output fluctuations continues, there is little disagreement that, as a rule, policy should not be procyclical. The standard Keynesian approach suggests that fiscal policy should act in a stabilizing manner, while within the neoclassical paradigm, tax-smoothing models imply that fiscal policy should remain neutral over the business cycle. Even in a Ricardian framework, where a reduction in taxes or an increase in spending leads to an equivalent rise in private sector saving, policy would not be expected to be procyclical.

    Nonetheless, procyclical policies may sometimes be warranted by the need to preserve the sustainability of public finances. Sustainability considerations can become overriding during economic downturns if public debt is not at prudent levels initially. This can be especially relevant for emerging market and developing countries facing an intrinsically more volatile macroeconomic environment and uncertain access to international capital markets. In the absence of adequate financial buffers, and constraints on borrowing, expenditure retrenchment in the downturn may be necessary.

    Yet there is no room for complacency regarding chronic procyclicality—and, in particular, systematically exuberant spending in good times—as this exacerbates volatility and damages fiscal sustainability. Although economic theory is ambiguous with regard to the impact of volatility on growth, most empirical studies find an inverse relationship, reflecting in part the adverse effect of volatility on capital investment and human capital formation. While weaker growth itself can jeopardize fiscal sustainability, a policy that is procyclical in good times can directly fuel debt accumulation as deficits incurred in downturns are not compensated for by surpluses during the rebound.

    However, there is empirical evidence that fiscal policy is frequently pro-cyclical, especially in upturns. This reflects a variety of economic, financial, and political factors. One explanation hinges on lags in the formulation and implementation of policy and difficulties concerning the assessment of the state of the cycle; another is based on the interaction between budgetary decisions and political economy factors, and emphasizes the political dimension of spending pressures arising in good times, with fiscal expansion in the upswing reducing room for countercyclical policy in the downturn. In developing countries, this effect is compounded by financial constraints and limited access to international capital markets. In these countries the need to make up for the compression in spending during downturns can in turn add to spending pressures in good times, resulting in a vicious cycle of procyclical policies.

    This chapter examines the cyclical properties of fiscal policy and explores three issues: the extent of procyclicality in both industrial and developing countries; the factors underlying the observed pattern of procyclicality; and the consequences of procyclicality, including the impact on countries’ debt ratios. The analysis finds that discretionary fiscal policy has generally been procyclical in good times in both industrial and developing countries, and that it has adversely affected both economic growth and budgetary sustainability.

    Evidence on Procyclicality

    Movements in the ratio of nominal fiscal balance to GDP are the net result of the automatic reaction of the budget to cyclical developments and discretionary policy. Hence, movements in nominal balance, while providing important indications regarding the cyclicality of the budget and budgetary sustainability, do not show the policy stance. For instance, an improvement of the fiscal balance in a cyclical upturn may yet entail a procyclical (expansionary) stance if there are sufficiently large automatic stabilizers.

    There is significant evidence that discretionary policy tends to be procy-clical in both industrial and developing countries. In industrial countries, movements in the ratio of overall fiscal balance to GDP are seen to be mildly countercyclical (see, e.g., Mélitz, 2002). In developing countries, the sensitivity of the fiscal balance to the economic cycle is generally low (IMF, 2003). But there are considerable differences across regions, with the sensitivity being lowest for the Latin American countries. In both industrial and developing countries, the cyclical sensitivity of nominal balances appears lower than would be expected based on the effect of automatic stabilizers alone, suggesting that discretionary policy exerts an offsetting impact.

    Recent, more systematic, analysis undertaken by the authors corroborates the above evidence. For industrial countries the results indicate that on average a 1 percentage point increase in the output gap results in an improvement of around 0.3 percentage point of GDP in the overall fiscal balance (Figure 3.1 and Table 3.1).1 Since the available estimates suggest that the effect of automatic stabilizers averages around ½ percent of GDP (van den Noord, 2000; Bouthevillain and others, 2001; and IMF, 2004), discretionary policy is seen to be procyclical. For developing countries our estimates indicate that the sensitivity of the overall balance to the output gap is close to zero. While the size of automatic stabilizers is certainly smaller in developing countries, it is unlikely to be zero or negative, again indicating procyclicality of discretionary policy.

    Source : www.elibrary.imf.org

    What are automatic stabilizers?

    Lee and Sheiner discuss what automatic stabilizers are, their components, history and impact on state and local fiscal policy.

    SERIES:

    The Hutchins Center Explains

    UP FRONT

    What are automatic stabilizers?

    Vivien Lee and Louise Sheiner Tuesday, July 2, 2019

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    Someday, the U.S. will suffer another recession. With interest rates already very low, monetary policy may not be able to carry the entire burden of mitigating economic downturns. Thus, the role of fiscal policy in economic stabilization is being viewed with increasing importance. But with political polarization in Washington, there is concern that Congress won’t move quickly enough to cut taxes or raise spending (known as discretionary fiscal policy) to buffer the effects of a crisis. So economists and others are looking towards expanding provisions in the law that automatically increase spending or reduce tax bills when the economy turns down.

    WHAT ARE AUTOMATIC STABILIZERS?

    Automatic stabilizers are mechanisms built into government budgets, without any vote from legislators, that increase spending or decrease taxes when the economy slows. During a recession, automatic stabilizers can ease households’ financial stress by decreasing their tax bills or by boosting cash and in-kind benefits, all without changes in the tax code or any other new legislation. For example, when a household’s income declines, it generally owes less in taxes, which helps cushion the blow. Additionally, with a decline in income, a household may become eligible for unemployment insurance (UI), food stamps (Supplemental Nutrition Assistance Program, or SNAP), or Medicaid.

    Vivien Lee

    Senior Research Assistant - Hutchins Center on Fiscal & Monetary Policy, The Brookings Institution

    Louise Sheiner

    The Robert S. Kerr Senior Fellow - Economic Studies

    Policy Director - The Hutchins Center on Fiscal and Monetary Policy

    lsheiner

    Automatic stabilizers don’t just help families facing financial difficulties—they also help the overall economy by stimulating aggregate demand when times are bad and when the economy is most in need of a boost. When times are better, automatic stabilizers generally phase down or turn off. Most automatic stabilizers are federal; states and localities are generally required to balance their budgets, so they can’t run big deficits during downturns.

    WHAT ARE THE COMPONENTS OF AUTOMATIC STABILIZERS?

    Both taxes and spending can have stabilizing effects on the economy. Most taxes have a stabilizing effect because they automatically move with economic growth. For example, personal and corporate income tax collections decline during recessions along with income and profits, and payroll tax collections decline when employment and wages fall. Spending on some transfer programs also depends on the state of the economy. For instance, outlays for unemployment insurance increase when the unemployment rate rises, and spending on anti-poverty programs like Medicaid and SNAP increases during recessions because bad economic times mean that more people are eligible.

    As shown in the chart below, the bulk of the value of automatic stabilizers comes from changes in tax revenues, rather than from spending on programs. According to the Congressional Budget Office (CBO), revenues have accounted for about three-quarters, on average, of the effect of automatic stabilizers on the budget over the past 50 years (

    CBO 2015).

    HOW ARE AUTOMATIC STABILIZERS DIFFERENT FROM CHANGES IN DISCRETIONARY FISCAL POLICY?

    One of the benefits of automatic stabilizers is that they do not require legislative action and respond quickly to economic downturns. Discretionary fiscal policy requires action from Congress, so there may be considerable time lags due to debates on the appropriate response, steps in the rulemaking process, and the administrative actions for funds to reach the pockets of consumers. During the Great Recession, Congress responded relatively quickly: the first fiscal action was the Bush Economic Stimulus Act, which was signed on February 13, 2008, which turned out to be only two months after the recession was later determined to have begun (Furman 2018). But the largest stimulus package, the American Recovery and Reinvestment Act (ARRA) of 2009, was authorized five quarters after the start of the recession. By this time, spending on automatic stabilizers had already grown to 2 percent of potential GDP—the maximum sustainable output of the economy (Schanzenbach 2016). Examining economic stabilization policy from 1980 to 2018, Sheiner and Ng (

    2019) find that automatic stabilizers provide about half of the total fiscal stabilization, with the other half provided by discretionary fiscal policy.

    HOW HAVE AUTOMATIC STABILIZERS CHANGED OVER TIME?

    The responsiveness of automatic stabilizers to economic conditions has been fairly stable over time. According to

    Source : www.brookings.edu

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