Subjective Short Answer
1. Why is it desirable, if possible, to use policy to offset the effects of a decrease in aggregate demand?
2. Some economists argue that policymakers can use monetary and fiscal policy to reduce the severity of economic
fluctuations. What are some things policymakers can do to boost the economy when aggregate demand is inadequate to
ensure full employment?
3. Some economists argue that policymakers can use monetary and fiscal policy to reduce the severity of economic
fluctuations. What are some things policymakers can do when higher inflation becomes a concern?
4. If net exports fall, what actions could a central bank take to stabilize the economy?
5. If businesses become more pessimistic about the future, what fiscal policies could the government take to stabilize the
economy?
6. Some economists argue that policymakers can use monetary and fiscal policy to reduce the severity of economic
fluctuations. In practice, however, there are obstacles to the use of such policies. What are the primary difficulties with
using monetary and fiscal policy to stabilize the economy?
7. Explain why fiscal policy actions typically work with a lag.
8. Why is there a lag between the Fed’s actions and the economy’s response?
9. Monetary policy affects aggregate demand with a lag. Approximately how long does it take for monetary policy actions
to affect aggregate demand?
10. Why might policymakers attempts to stabilize the economy do more harm than good?
11. According to traditional Keynesian analysis, which has a greater impact on aggregate demand, changing taxes or
changing government expenditures? Why?
12. List two of the three types of fiscal programs that the President and Congress emphasized in response to the 2008-
2009 recession.
13. What component of GDP is particularly volatile over the business cycle and can be targeted by tax cuts?
14. Why might the response of far-sighted consumers reduce the multiplier effect of an increase in government
expenditures?
15. Explain how tax cuts can increase aggregate supply.
16. Advocates of cutting taxes rather than increasing government expenditures in response to a recession argue that the
increase in spending by consumers and business may be more effective than that of the government. Explain this
argument.
17. While traditional Keynesian analysis indicates that increases in government purchases are a more potent tool than
decreases in taxes to stimulate the economy, what are some of the reasons why tax cuts might be preferred to increased
government spending?
18. Approximately how often does the Federal Open Market Committee meet?
19. Which part of the Federal Reserve determines monetary policy? How often does it meet? What does it set a target for?
20. According to a 1977 amendment to the Federal Reserve Act of 1913, what are the goals the Fed should promote?
21. According to a 1977 amendment to the Federal Reserve Act of 1913, what weights should the Fed put on the goals of
maximum employment, stable prices, and moderate long-term interest rates?
22. By law what goals are the Federal Reserve to pursue? What, if any, specific weights are given for these goals?
23. What is meant by the political business cycle?
24. Explain what is meant by the time inconsistency of monetary policy.
25. According to political business cycle theory, if the Fed wanted to increase the chances of a President’s re-election,
what specific actions might it take?
26. Suppose the nation’s price level rises as a result of an increase in aggregate demand and a decrease in aggregate
supply which leaves output unchanged. If the Fed is required to follow a rule that stabilizes the price level, what will the
Fed do to the money supply and what impact will this have on total output in the economy?
27. What did the actions of the Federal Reserve during the 1990’s demonstrate about monetary policy and rules?
28. List two costs of inflation.
29. Economists believe that a little bit of inflation may be a good thing. What are the potential benefits of inflation?
aggregate demand. Inflation allows for the possibility of negative real interest rates
30. One concern of those who oppose the central bank targeting inflation at zero is that reducing inflation is costly. What
is the cost of reducing the inflation rate?
A temporary recession.
31. Using typical estimates of the sacrifice ratio, how much output would likely be sacrificed to reduce inflation by 3
percent?
percent would sacrifice about 15 percent of one year’s output.
32. Using typical estimates of the sacrifice ratio, how much output would likely be sacrificed to reduce inflation from 4
percent to 2 percent?
33. Provide two specific ways in which reducing inflation might leave “permanent scars” on the economy.
34. Those who believe the central bank should aim for zero inflation argue that reducing inflation is a policy with
temporary costs and permanent benefits. What are the primary costs and benefits they are referring to?
35. Proponents of requiring the government to balance its budget argue that debt burdens future generations. Explain one
claim they make to support this argument.
36. Suppose a country has a real growth rate of 3%. Government spending is 75 billion units of currency and its tax
revenues are 60 billion units of currency. The current national debt is 300 billion units of currency. At what inflation rate
will its debt-to-income ratio remain unchanged?
37. Suppose that a country has an inflation rate of about 3 percent per year and a real GDP growth rate of about 3 percent
per year. How large of a deficit can the government run (as a percentage of GDP) without raising the debt-to-income
ratio?
38. During recessions, even with no changes in policy, the deficit tends to ______ because _____________.
39. Are there any situations in which running a budget deficit is justified? Explain.
40. Provide an example of how current expenditures might benefit future generations.
41. What is the benefit of a high saving rate?
42. Suppose a 25-year-old worker purchases a $5,000 bond that pays 6% interest per year which she plans to withdraw
when she retires in 40 years. How much will the $5,000 accumulate to in 40 years? If the worker faces a marginal tax rate
of 30% on interest income, how much will the $5,000 accumulate to in 40 years?
43. In addition to the tax code, other policies reduce the incentives for people to save Provide an example.
44. A higher return on saving ______ the amount a household needs to save to achieve any target level of future
consumption. This effect on saving is called the _______ effect. If the income effect is large enough, then a reduction in
taxes on saving might ______ tax revenues.
45. Suppose tax policies are changed to encourage saving. Explain how the income effect and substitution effect influence
the amount saved.
46. Explain what is meant by saying that capital income is taxed twice.
47. Why might reforms to encourage saving lead to a less egalitarian society?
48. Explain the main arguments in favor of economic stabilization.
49. Explain why policy lags could make stabilization policies counterproductive.
50. Which kind of lag is important for monetary policy? Which kind of lag is important for fiscal policy?
51. Suppose that changes in aggregate demand tended to be infrequent and that it takes a long time for the economy to
return to long-run output. How would this affect the arguments of those who oppose using policy to stabilize output?
52. Suppose that changes in aggregate demand tended to be infrequent and that it takes a long time for the economy to
return to long-run output. How would this affect the arguments of those who oppose using policy to stabilize output?
53. Carefully explain how monetary policy can be used to counter a recession. Explain what the central bank does as well
as how its actions affect the economy. Under what circumstances is fiscal policy especially useful?
54. Why might government expenditures be more appropriate than tax cuts to counter recessions? Is there any evidence
for this thinking?
55. Why might tax cuts be more appropriate than increasing government expenditures to counter recessions? Is there any
evidence for this thinking?
56. What fiscal policies did the government implement in response to the 2008-2009 recession? Can we be certain that
these policies were effective? Explain.
57. What is the political business cycle and how does it relate to whether the central bank should have discretion or use a
rule?
58. Explain the time inconsistency of monetary policy.
59. Describe three costs of inflation.
60. Suppose a country has had a high and relatively stable inflation rate for a long time. How might this affect the costs
and benefits of inflation reduction?
61. What’s the basis for arguing that deficits are likely to lead to lower living standards in the future?
62. Suppose that the government goes into deficit in order to help local school districts build better schools. Does this
burden future generations?
63. Explain how it is possible for the government debt to grow forever.
64. Is it possible that deficits do not burden future generations?
65. Identify three government policies that discourage saving.
66. Means-tested government programs tend to reduce saving. What are means-tested programs and how do they reduce
saving?
67. Why do many economists advocate a consumption tax rather than an income tax?
68. Explain how a higher rate of return on saving could, at least in theory, lead to lower saving.
69. Explain how tax provisions to encourage private saving may reduce national saving.