47) Describe the differences (in sign and relative magnitude) between the government purchases
multiplier and the tax multiplier.
48) What economic impact would the closing of a nearby military base have on a town? Would people
and businesses that did not directly deal with the military personnel be affected?
49) Explain why the tax multiplier is different from the government purchases multiplier, in both sign
and relative magnitude.
62
50) Suppose real GDP is currently $12.5 trillion and potential real GDP is $13 trillion. If the president
and Congress increased government purchases by $500 billion, what would be the result on the
economy?
51) If real GDP is $300 billion below potential GDP and the tax multiplier equals -1.5, then how much
would the government need to change taxes to bring the economy to equilibrium at potential?
52) Suppose that the current equilibrium GDP is $14.5 trillion and that potential GDP is $14.3 trillion.
Will decreasing government purchases by $200 billion, or raising taxes by $200 billion, restore the
economy to potential GDP? Explain.
16.5 The Limits to Using Fiscal Policy to Stabilize the Economy
1) The Federal Reserve plays a larger role than Congress and the president in stabilizing the economy
because
A) the Federal Reserve can more quickly change monetary policy than the president and the Congress
can change fiscal policy.
B) the Federal Reserve can immediately recognize when real GDP is below or above potential GDP.
C) changes in interest rates have a considerably larger effect on the economy than changes in
government purchases or taxes.
D) changes in interest rates have their full effect on the economy in a short period of time, whereas
changes in government spending and taxes have their full effect over a long period of time.
2) The use of fiscal policy to stabilize the economy is limited because
A) changes in government spending and tax rates have a small effect on aggregate demand.
B) changes in government spending and tax rates have a small effect on interest rates.
C) the legislative process can be slow, which means that it is difficult to make fiscal policy actions in a
timely way.
D) the Internal Revenue Service (IRS) resists changes in tax rates because of all the changes they would
have to make to the tax code.
3) Data indicates that recessions following financial crises ________ recessions which do not follow
financial crises.
A) are more severe than
B) are less severe than
C) are equally severe as
D) Data does not show any link between the severity of recessions following financial crises.
4) Compared to the averages for post World War II recessions, the recession of 2007-2009 was ________
in duration and the decline in real GDP was ________.
A) longer; greater
B) longer; smaller
C) shorter; greater
D) shorter; smaller
5) Crowding out refers to a decline in ________ as a result of an increase in ________.
A) tax revenues; unemployment
B) government purchases; tax rates
C) government purchases; private expenditures
D) private expenditures; government purchases
6) The crowding out of private spending by government spending will be greater the
A) less sensitive consumption, investment, and net exports are to changes in interest rates.
B) more sensitive consumption, investment, and net exports are to changes in interest rates.
C) less sensitive consumption, investment, and net exports are to changes in the price level.
D) more sensitive consumption, investment, and net exports are to changes in the price level.
7) An increase in the sensitivity of private spending (consumption, investment, and net exports) to
changes in the interest rate ________ the government purchases multiplier.
A) will decrease
B) will increase
C) will not change
D) may increase or may decrease
8) The impact of crowding out may be the least
A) during a deep recession.
B) when real GDP is above but close to potential GDP.
C) during an expansion.
D) when real GDP is below but close to potential GDP.
9) In the long run, most economists agree that a permanent increase in government spending leads to
________ crowding out of private spending.
A) no
B) partial
C) complete
D) more than complete
10) Expansionary fiscal policy
A) can be effective in the short run.
B) causes complete crowding out in the short run.
C) is never effective because of crowding out.
D) can be effective in the long run.
11) In the long run, most economists agree that a permanent increase in government spending leads to
A) no decrease in private spending.
B) a decrease in private spending by less than the amount that government spending increased.
C) a decrease in private spending by the same amount that government spending increased.
D) a decrease in private spending by more than the amount that government spending increased.
12) In early 2008, the housing crisis and rising oil prices increased the risk of recession in the United
States. What fiscal policy action was taken by Congress and the president to counter these events?
A) The Federal Reserve cut its target for the federal funds rate.
B) There was an increase in government spending on defense and unemployment compensation.
C) Taxpayers were given rebates on taxes they already paid.
D) Income taxes were raised to reduce the federal budget deficit and reduce interest rates.
13) A tax rebate, like the one issued in 2008, is likely to ________ consumption spending ________ than
would a permanent tax cut.
A) increase; more
B) increase; less
C) decrease; more
D) decrease; less
14) When President Obama took office in January 2009, he pledged to pursue an expansionary fiscal
policy to try to pull the economy out of the recession. The next month, Congress passed the American
Recovery and Reinvestment Act of 2009, an $840 billion package of spending increases and tax cuts that
was
A) the largest fiscal policy action in U.S. history.
B) second in size only to the fiscal policy action taken during the Great Depression.
C) small in comparison to the actions taken during the recession of 1974-1975
D) roughly equal to the spending increases and tax cuts implemented during the recession of 1980-1982.
15) Of the $840 billion American Recovery and Reinvestment Act stimulus package which was enacted
in 2009, approximately ________ took the form of tax cuts and ________ took the form of increases in
government expenditures.
A) one-half; one-half
B) three-fourths; one-fourth
C) one-tenth; nine-tenths
D) one-third; two-thirds
16) Of the $840 billion American Recovery and Reinvestment Act stimulus package which was enacted
in 2009, the largest spending increase occurred in which category?
A) energy and the environment
B) military, veterans, and homeland security
C) health care, social services, and education
D) transportation and housing
17) In preparing their estimates of the stimulus package’s effect on GDP, Obama administration
economists estimated a government purchases multiplier of 1.57. Economist Robert Barro argues that
during wartime, the government purchases multiplier would be ________ the administration’s estimate,
and economists Lawrence Christiano, Martin Eichenbaum, and Sergio Rebelo argued that when short-
term interest rates are near zero, the multiplier would be ________ the administration’s estimate.
A) higher than; lower than
B) lower than; higher than
C) higher than; equal to
D) equal to; lower than
18) In preparing their estimates of the stimulus package’s effect on GDP, Obama administration
economists estimated a government purchases multiplier of 1.57. This indicates that a $1 billion increase
in government purchases would increase equilibrium real GDP by
A) $1 billion.
B) $1.57 billion.
C) $15.7 billion.
D) $157 billion.
19) Poorly timed discretionary policy can do more harm than good. Getting the timing right with fiscal
policy is generally
A) less difficult than with monetary policy.
B) far less difficult than with monetary policy.
C) more difficult than with monetary policy.
D) about the same difficulty as with monetary policy.
20) It is ________ difficult to effectively time fiscal policy than monetary policy because ________.
A) more; fiscal policy can be quickly decided and changed
B) more; fiscal policy takes longer to implement
C) less; monetary policy takes longer to decide and change
D) less; monetary policy takes longer to implement
21) A(n) ________ in private expenditures as a result of a(n) ________ in government purchases is called
crowding out.
A) increase; decrease
B) decrease; decrease
C) decrease; increase
D) increase; increase
22) if government spending and the price level increase, then
A) the interest rate increases, consumption declines, and investment spending declines.
B) the interest rate decreases, consumption declines, and investment spending declines.
C) the interest rate increases, consumption increases, and investment spending increases.
D) the interest rate decreases, consumption increases, and investment spending increases.
23) Crowding out, following an increase in government spending, results from (the exchange rate is the
foreign exchange price of the domestic currency)
A) higher interest rates and a lower exchange rate.
B) higher interest rates and a higher exchange rate.
C) lower interest rates and a lower exchange rate.
D) lower interest rates and a higher exchange rate.
24) Crowding out will be greater
A) the less sensitive consumption spending is to changes in the interest rate.
B) the further equilibrium GDP is below potential GDP.
C) the more sensitive investment spending is to changes in the interest rate.
D) if the economy is in recession, rather than at full employment.
25) If policymakers implement an expansionary fiscal policy but do not take into account the potential
for crowding out, the new equilibrium level of GDP is likely to
A) be at potential GDP.
B) be above potential GDP.
C) be below potential GDP.
D) There is insufficient information given here to draw a conclusion.
26) Following a decrease in government spending, as the price level falls we would expect the level of
interest rates to ________ and investment to ________.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase
27) An increase in government spending may expedite recovery from a recession in the short run, but in
the long run this policy may
A) reduce investment in new capital.
B) make domestic businesses less competitive in international markets as the dollar appreciates in value.
C) raise interest rates and reduce consumer expenditures on automobiles and new houses.
D) All of the above are correct.
28) Increases in government spending result in ________ in the short run, and permanent increases in
government spending result in ________ in the long run.
A) partial crowding out; partial crowding out
B) partial crowding out; complete crowding out
C) complete crowding out; complete crowding out
D) complete crowding out; partial crowding out
29) When President Obama took office in January 2009, he pledged to pursue an expansionary fiscal
policy to try to pull the economy out of the recession. The next month, Congress passed the American
Recovery and Reinvestment Act of 2009, a $840 billion package of ________ that was the largest fiscal
policy action in U.S. history.
A) spending increases and tax cuts
B) interest rate reductions and increases in the money supply
C) treasury bond purchases and mortgage-backed securities purchases
D) commercial and investment bank bailouts
30) Of the $840 billion American Recovery and Reinvestment Act stimulus package which was enacted
in 2009, approximately one-third took the form of ________ and two-thirds took the form of increases in
________.
A) discretionary government spending; transfer payments
B) tax rebates; tax cuts
C) treasury bond purchases; the money supply
D) tax cuts; government expenditures
31) Of the $840 billion American Recovery and Reinvestment Act stimulus package which was enacted
in 2009, the largest tax cuts occurred in which category?
A) business tax cuts
B) energy tax cuts
C) individual tax cuts
D) infrastructure tax cuts
32) In preparing their estimates of the stimulus package’s effect on GDP, Obama administration
economists estimated a government purchases multiplier of 1.57. Economist Robert Barro argues that
________, the government purchases multiplier would be lower than the administration’s estimate, and
economists Lawrence Christiano, Martin Eichenbaum, and Sergio Rebelo argued that ________, the
multiplier would be higher than the administration’s estimate.
A) during a recession; when the inflation rate is relatively low
B) when the unemployment rate is high; when the value of the dollar is depreciating against foreign
currencies
C) when the federal budget is in surplus; when government transfer payments are declining
D) during wartime; when short-term interest rates are near zero
33) In preparing their estimates of the stimulus package’s effect on GDP, Obama administration
economists estimated a government purchases multiplier of 1.57. This indicates that a ________ increase
in government purchases would increase equilibrium real GDP by $157 billion
A) $1 billion
B) $10 billion
C) $100 billion
D) $157 billion
34) The gap between potential GDP and real GDP had been as large as 7 percent during the worst of the
2007-2009 recession. By 2015, the gap
A) had been eliminated.
B) was still nearly 3 percent.
C) remained at 7 percent.
D) was positive, with real GDP exceeding potential GDP.
35) Crowding out refers to a decrease in government purchases as a result of an increase in private
expenditures.
36) As spending on government purchases increases, income rises and money demand falls.
37) An increase in government spending will force an appreciation of the dollar, which causes net
exports to fall.
38) An increase in government spending lowers interest rates and increases the rate of investment in
new capital.
39) Long lags associated with the legislative process in implementing fiscal policy make it more difficult
to use than monetary policy.
40) Why will there be less crowding out of private spending by government spending the less sensitive
consumption, investment, and net exports are to changes in interest rates?
41) If Congress and the president pursue an expansionary fiscal policy at the same time as the Federal
Reserve pursues an expansionary monetary policy, how might the expansionary monetary policy affect
the extent of crowding out in the short run?
42) Explain why the timing of fiscal policy may be more difficult than the timing of monetary policy.
43) What is meant by crowding out? Explain the difference between crowding out in the short run and
in the long run.
16.6 Deficits, Surpluses, and Federal Government Debt
1) To evaluate the size of the federal budget deficit or surplus over time, it would be best to look at the
A) absolute size of the budget deficit or surplus.
B) budget deficit or surplus as a percentage of GDP.
C) budget deficit or surplus as a percentage of tax revenues.
D) budget deficit or surplus as a percentage of government spending.
2) Historically, the largest U.S. federal budget deficits as a percentage of GDP in the 20th century
occurred during
A) World War I and World War II.
B) the Great Depression.
C) 1970-1997.
D) the Vietnam war.
E) 1998-1999.
3) During 1970-1997, the U.S. federal government was
A) in surplus every year.
B) balanced every year.
C) in deficit every year.
D) in deficit most of those years.
4) A recession tends to cause the federal budget deficit to ________ because tax revenues ________ and
government spending on transfer payments ________.
A) increase; rise; falls
B) increase; fall; rises
C) decrease; rise; falls
D) decrease; fall; rises
5) An economic expansion tends to cause the federal budget deficit to ________ because tax revenues
________ and government spending on transfer payments ________.
A) increase; rise; falls
B) increase; fall; rises
C) decrease; rise; falls
D) decrease; fall; rises
6) The cyclically adjusted budget deficit or surplus measures what the deficit or surplus would be if the
economy was
A) in a recession.
B) in an expansion.
C) at potential GDP.
D) at potential tax revenue.
7) Suppose the federal budget deficit for the year was $100 billion and the economy was in a recession.
If the economy had been at potential GDP, it is estimated that tax revenues would have been $60 billion
higher and government spending on transfer payments $50 billion lower. Using these estimates, the
cyclically adjusted budget
A) deficit was $210 billion.
B) deficit was $110 billion.
C) surplus was $10 billion.
D) surplus was $110 billion.
8) The automatic budget surpluses and budget deficits that occur in the federal budget over the
business cycle
A) destabilize the economy.
B) stabilize the economy.
C) decrease potential GDP.
D) increase potential GDP.
9) During the Great Depression, what appeared to be ________ fiscal policy was actually not when the
________ budget deficit or surplus is examined.
A) expansionary; actual
B) expansionary; cyclically adjusted
C) contractionary; actual
D) contractionary; cyclically adjusted
10) For the federal deficit to be lowered,
A) the federal government must decrease its spending and increase net exports.
B) the federal government’s expenditures must be lower than its tax revenue.
C) the Federal Reserve must raise interest rates and lower the required reserve ratio.
D) the Federal Reserve must reduce the money supply.
11) The federal government debt equals
A) tax revenues minus government spending.
B) government spending minus tax revenues.
C) the accumulation of past budget deficits.
D) the total value of U.S. Treasury bonds outstanding.
12) The federal government debt as a percentage of GDP fell
A) from 2002-2007.
B) from 1980-1992.
C) during World War I and World War II.
D) from 1998-2001.
E) during the Great Depression.
13) Which of the following is a reason why we should consider the federal national debt a problem?
A) The federal government is in danger of defaulting on its debt.
B) If the debt drives up interest rates, crowding out will occur.
C) If the debt was incurred to finance improvements in infrastructure, crowding out will occur.
D) If the debt was incurred to finance research and development, crowding out will occur.
14) If the federal government’s expenditures are less than its tax revenues, then
A) a budget surplus results.
B) a budget deficit results.
C) the budget is balanced.
D) No conclusion can be drawn here regarding the budget surplus or deficit without information
regarding government purchases versus other outlays.
15) During the twentieth century, the largest budget deficits as a percentage of GDP occurred
A) during the 1990s.
B) during the 1980s.
C) during the Vietnam war.
D) during World Wars I and II.
16) Government deficits tend to increase during
A) recessions and booms.
B) periods of war and recession.
C) periods of below- or above-average growth.
D) periods of increased financial uncertainty.
17) In recent economic history, the U.S. federal budget was in surplus from
A) 2001 through 2005.
B) 1998 through 2001.
C) 1990 through 1997.
D) 1980 through 1989.