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8840 Six Debates over Macroeconomic Policy
Problems
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?
Six Debates over Macroeconomic Policy 8841
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?
8842 Six Debates over Macroeconomic Policy
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?
Six Debates over Macroeconomic Policy 8843
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.
8844 Six Debates over Macroeconomic Policy
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.
Six Debates over Macroeconomic Policy 8845
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?
8846 Six Debates over Macroeconomic Policy
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?
Six Debates over Macroeconomic Policy 8847
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?
8848 Six Debates over Macroeconomic Policy
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?
Six Debates over Macroeconomic Policy 8849
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?
8850 Six Debates over Macroeconomic Policy
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?
31. Using typical estimates of the sacrifice ratio, how much output would likely be sacrificed to reduce
inflation by 3 percent?
32. Using typical estimates of the sacrifice ratio, how much output would likely be sacrificed to reduce
inflation from 4 percent to 2 percent?
Six Debates over Macroeconomic Policy 8851
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?
8852 Six Debates over Macroeconomic Policy
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?
Six Debates over Macroeconomic Policy 8853
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.
8854 Six Debates over Macroeconomic Policy
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.
Six Debates over Macroeconomic Policy 8855
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.
8856 Six Debates over Macroeconomic Policy
47. Why might reforms to encourage saving lead to a less egalitarian society?
