Economics Special Topic 7—The Federal Budget and the National Debt
MULTIPLE CHOICE
1. Which of the following is true?
a.
A budget deficit will reduce the national debt.
b.
A budget deficit will increase the national debt.
c.
A balanced budget will increase the national debt.
d.
A budget surplus will increase the national debt.
2. In 2012, more than 60% of the privately held national debt was held by
a.
foreign investors.
b.
Federal Reserve banks.
c.
large corporations.
d.
government trust funds.
3. It is important to distinguish between the privately held portion of the national debt and the portion
held by government agencies and the Federal Reserve system because
a.
the government will not have to repay the privately held debt.
b.
only the privately held debt creates a net interest liability for the federal government.
c.
the privately held debt does not create a net interest liability for the federal government.
d.
taxes will have to be raised in order to pay the interest on the debt held by the Federal
Reserve system.
4. From a public choice viewpoint, the persistent budget deficits of recent decades are
a.
surprising, because politicians have a strong incentive to balance the government’s budget.
b.
an expected result, because the political incentive structure makes it attractive for
politicians to levy taxes rather than spend on current programs.
c.
surprising, because politicians have a strong incentive to run budget surpluses and thereby
indicate that their actions have generated a profit.
d.
an expected result, because the political incentive structure makes it attractive for
politicians to spend on current programs rather than levy taxes.
5. How does inclusion of the current revenues and expenditures of the Social Security trust fund into the
budget calculation currently affect the reported budget deficit of the federal government?
a.
It increases the reported deficit.
b.
It reduces the reported deficit.
c.
It exerts no effect on the reported deficit.
d.
It increases the deficit during an economic boom but reduces it during a recession.
6. What is the difference between the federal budget deficit and the national debt?
a.
The budget deficit is the amount by which expenditures exceed revenues in a particular
year, while the national debt is the cumulative effect of all past budget deficits and
surpluses.
b.
The budget deficit is the cumulative effect of all prior national debts.
c.
The national debt includes all outstanding bonds, while the budget deficit excludes bonds
held by government agencies.
d.
This is a trick question because there is no difference between the budget deficit and the
national debt.
7. The national debt is the
a.
difference between a nation‘s exports and imports of goods and services.
b.
sum of the personal debt of all citizens in the United States.
c.
indebtedness of the federal government in the form of outstanding interest-earning bonds.
d.
sum of the net personal debts of Americans to foreigners.
8. The national debt is
a.
the difference between a nation’s exports and imports of goods and services.
b.
the sum of the personal debt of all citizens in the United States.
c.
the cumulative effect of all past budget deficits and surpluses of the federal government.
d.
equal to the current size of the budget deficit.
9. The total indebtedness of the federal government in the form of outstanding interest-earning bonds is
the
a.
budget deficit.
b.
budget surplus.
c.
national debt.
d.
trade deficit.
10. The sum of all past budget deficits and surpluses of the federal government is the
a.
budget deficit.
b.
budget surplus.
c.
national debt.
d.
trade deficit.
11. If the federal government were to run a budget deficit, this would
a.
increase the size of the national debt.
b.
reduce the size of the national debt.
c.
leave the size of the national debt unchanged.
d.
increase the national debt only if the government also expands the supply of money.
12. If the federal government were to run a budget surplus, this would
a.
increase the size of the national debt.
b.
reduce the size of the national debt.
c.
leave the size of the national debt unchanged.
d.
decrease the national debt only if the government also reduces the supply of money.
13. What determines the creditworthiness of any organization, including the federal government?
a.
the size of its debt relative to its income base
b.
the interest rate at which it can borrow money
c.
the length of time it has existed
d.
the length of time it is expected to operate
14. If the federal government runs a budget deficit, but the budget deficit as a percent of GDP is less than
the growth rate of real output, the
a.
national debt will decrease as a share of GDP.
b.
national debt will remain a constant share of GDP.
c.
national debt will increase as a share of GDP.
d.
size of the national debt (in dollar value) will decline.
15. If the federal government runs a budget deficit, and the budget deficit as a percent of GDP is equal to
the growth rate of real output, the
a.
national debt will decrease as a share of GDP.
b.
national debt will remain a constant share of GDP.
c.
national debt will increase as a share of GDP.
d.
size of the national debt (in dollar value) will decline.
16. During the 1950s and 1960s, the national debt as a percent of GDP in the United States
a.
soared to an all-time high.
b.
declined.
c.
increased.
d.
was virtually unchanged.
17. At year-end 2014, the national debt of the United States was approximately
a.
5 percent of GDP.
b.
25 percent of GDP.
c.
77 percent of GDP.
d.
107 percent of GDP.
18. Suppose a new country is formed, and its government has the following revenues and expenditures for
its first three years of existence.
Government
Government
Year
Revenues
Expenditures
First
$100
$130
Second
$150
$140
Third
$200
$205
Which of the following is correct regarding this government?
a.
In the third year, it had a $5 national debt, and after the third year, it has a $25 deficit.
b.
In the third year, it ran a $5 deficit, and its national debt after the third year is $45.
c.
In the third year, it ran a $5 surplus, and its national debt after the third year is $25.
d.
In the third year, it ran a $5 deficit, and its national debt after the third year is $25.
19. In 2012, approximately what percent of the national debt was held by the Federal Reserve system?
a.
5 percent
b.
10 percent
c.
40 percent
d.
55 percent
20. In 2012, approximately what percent of the national debt was held by federal government agencies?
a.
1 percent
b.
19 percent
c.
29 percent
d.
a little more than 80 percent
21. As of December, 2012, the privately held portion of the national debt was approximately
a.
5 percent of the total.
b.
20 percent of the total.
c.
60 percent of the total.
d.
80 percent of the total.
22. What percent of the privately held national debt was owed to foreign investors in 2012?
a.
1.5 percent
b.
approximately 20 percent
c.
approximately 60 percent
d.
more than 80 percent
23. The privately held government debt is that portion of the national debt that
a.
must be paid off at some point in the future.
b.
is owed to domestic and foreign investors.
c.
cannot be refinanced by issuing new debt.
d.
is owned by agencies of the federal government.
24. If one subtracts the amount of bonds held by agencies of the federal government and the Federal
Reserve from the national debt, what remains is known as the
a.
external debt.
b.
privately held government debt.
c.
trade deficit.
d.
budget deficit.
25. Why are the bonds held by the Fed and government agencies excluded from the privately held debt
figures?
a.
The U.S. Treasury does not have to pay off these bonds.
b.
These bonds were not issued by the U.S. Treasury.
c.
These bonds do not create a net-interest obligation for the federal government.
d.
These bonds are not interest-bearing bonds.
26. External debt is that portion of the national debt
a.
held by private investors.
b.
held by the Federal Reserve.
c.
that the United States does not intend to repay.
d.
held by foreigners.
27. The U.S. Treasury both pays and receives almost all of the interest on that portion of the national debt
that is held by
a.
domestic investors.
b.
foreign investors.
c.
government agencies and the Federal Reserve system.
d.
commercial banks.
28. Which of the following portions of the national debt impose a net interest burden on the federal
government?
a.
treasury bonds held by government agencies
b.
treasury bonds held by private investors
c.
treasury bonds held by the Federal Reserve system
d.
treasury bonds held in the Social Security Trust Fund
29. Currently, the Federal Reserve earns approximately $30 billion of interest annually on its holdings of
government bonds. Only a small portion of these earnings is required to cover the Fed’s operating
costs. The remainder of these earnings is
a.
distributed to the member banks of the Federal Reserve system.
b.
invested in corporate stocks held by the Fed.
c.
returned to the U.S. Treasury.
d.
loaned to commercial banks.
30. The idea that a large public debt is “mortgaging the future of our children and grandchildren” is
misleading because
a.
it is the Federal Reserve that will be responsible for making interest payments on the debt.
b.
future generations will have to bear the opportunity costs of the resources that are used
today.
c.
future generations will not be liable for the interest obligations of the national debt.
d.
future generations will inherit the interest income as well as the interest obligations.
31. When government debt is financed internally, future generations will
a.
inherit a higher tax liability without additional interest income.
b.
inherit neither higher taxes nor additional interest income.
c.
inherit both higher taxes and additional interest income.
d.
receive lower interest income and a lower tax liability.
32. Which of the following is true of deficit spending and government debt?
a.
The opportunity costs of government spending must be incurred today and cannot be
passed on through deficit spending.
b.
Because of the national debt, future generations will incur liabilities without any
corresponding benefits.
c.
Financing government spending with debt allows the government to pass the opportunity
costs of government spending along to future generations.
d.
All of the public debt is owed to foreigners because the people who pay taxes are U.S.
citizens.
33. Which of the following is a valid concern about the national debt for a country whose debt is held
entirely by its citizens?
a.
The welfare of future generations will be directly related to the per-capita size of the
national debt that they inherit.
b.
Growth of the national debt will eventually lead to the bankruptcy of the government.
c.
When the debt comes due, future generations may be unable to pay it off.
d.
If the increases in the national debt reduce private expenditures on capital formation,
future generations may have lower incomes because they will inherit a smaller stock of
capital.
34. Deficit spending and a large national debt can have important effects on future generations because
they
a.
make it possible for those living in the present to pass the opportunity costs of current
government spending on to future generations.
b.
can significantly impact spending on capital formation.
c.
will pass interest obligations on to future generations with no corresponding benefits.
d.
will cause the government to go bankrupt.
35. According to the traditional (crowding-out) view, large budget deficits during normal times will lead
to
a.
bank failures in the future.
b.
a smaller capital stock in the future.
c.
lower interest rates in the future.
d.
a bankrupt government in the future.
36. If households fail to recognize that debt-financing represents a future liability (in the form of higher
taxes), they will tend to consume
a.
less and pass less net wealth on to future generations.
b.
more and pass more net wealth on to future generations.
c.
less and pass more net wealth on to future generations.
d.
more and pass less net wealth on to future generations.
37. The new classical view of fiscal policy holds that
a.
budget deficits will stimulate consumption.
b.
budget deficits will decrease the saving rate.
c.
individuals fail to recognize that debt-financing implies higher future taxes.
d.
individuals fully anticipate the added tax liability implied by the debt financing and will
increase their saving so they can meet this obligation.
38. The new classical view argues that an increase in government debt will cause people to
a.
increase their current saving so they will be better able to pay the higher future taxes
implied by the increase in the debt.
b.
increase their current consumption since the substitution of debt for taxes makes them
wealthier.
c.
shift their savings to foreign banks where they will be more secure.
d.
do all of the above.
39. According to the new classical view, if people appropriately realize that an increase in government
debt implies higher future taxes, they will
a.
save less since the substitution of debt for taxes makes them wealthier.
b.
increase their consumption since the substitution of debt for taxes makes them wealthier.
c.
save more now to meet the future tax liability implied by the increase in debt.
d.
alter neither their saving nor their consumption rate.
40. The new classical view of budget deficits assumes that
a.
people view government bonds as an addition to their wealth.
b.
individuals do not anticipate the tax liability implied by deficit spending.
c.
increased government borrowing will raise the interest rate and retard private borrowing
and capital formation.
d.
if future taxes (debt) are substituted for current taxes, people will save the reduction in
current taxes in order to pay the higher future taxes.
41. When is debt financing most likely to harm future generations of Americans?
a.
When the debt is held by domestic investors.
b.
Any time the debt is held by foreign investors.
c.
When the debt is held by foreign investors and the funds are channeled into productive
investment projects.
d.
When the debt is held by foreign investors and the funds are used to finance either current
consumption or unproductive investments.
42. When the United States ran large budget deficits during 2001-2011,
a.
private investment was strong and consumer expenditures declined as a percentage of
GDP.
b.
private investment was weak and consumption increased as a share of GDP.
c.
the trade deficit of the United States shrank, indicating that borrowing from foreigners
was declining.
d.
the deficits were financed exclusively through borrowing from domestic sources.
43. The large budget deficits of 2001-2011 were
a.
financed entirely through borrowing from domestic sources.
b.
accompanied by a rapid increase in private investment, which will enhance the welfare
of future generations of Americans.
c.
accompanied by an increase in consumption as a share of GDP, which indicates the
current generation of Americans is gaining at the expense of future generations.
d.
accompanied by large trade surpluses, which will enhance the welfare of future
generations of Americans.
44. As the size of a nation’s outstanding debt gets larger and larger relative to the size of the economy,
a.
eventually it will become difficult for the country to borrow in global credit markets.
b.
the country will have to pay higher real interest rates in order to induce investors to
purchase its bonds.
c.
at some point, the country will be more or less forced to bring spending into line with
revenues in order to maintain the confidence of investors.
d.
all of the above are correct.
45. A government with a national debt that is large and growing relative to the size of the economy will
a.
eventually find it difficult to borrow in global credit markets.
b.
be able to borrow at lower interest rates than countries with less outstanding debt.
c.
have to allocate a large and growing amount of tax revenue to the payment of interest on
the outstanding debt.
d.
do both a and c.
46. When a nation has a high debt/GDP ratio, that nation generally will
a.
require high taxes just to pay interest on the debt.
b.
be able to borrow funds at relatively low real interest rates.
c.
find that its bonds are attractive to international investors seeking low-risk investments.
d.
want to increase spending in order to gain the confidence of international investors.
47. As conventionally measured, budget deficit and surplus calculations include the revenues and
expenditures of
a.
only current government operations; government trust funds are omitted.
b.
all government trust funds except Social Security.
c.
the Social Security Trust Fund, but other government trust funds are omitted.
d.
all government trust funds, including Social Security.
48. Currently, the strategy of the Social Security system is to run surpluses to prepare for the retirement of
the baby boom generation. The effectiveness of this strategy is being undermined because
a.
rising interest rates make it more expensive for Social Security to borrow.
b.
inflation is reducing the value of the Social Security surplus.
c.
the trust fund is being used to finance current government expenditures, and the bonds
held by the trust fund are an obligation of the U.S. Treasury.
d.
the federal budget surplus reduces the Social Security surplus.
49. Widespread acceptance of the Keynesian theory of fiscal policy
a.
caused most economists to reject the public choice view of budget deficits.
b.
relaxed the political pressure to balance the budget and, hence, paved the way for the
persistent budget deficits of the last five decades.
c.
was based on the view that continual budget deficits would help stabilize the economy.
d.
increased the pressure for a constitutional amendment mandating that the federal
government balance its budget.
50. Public choice analysis explains that
a.
politicians have strong incentives to favor deficit finance over tax finance.
b.
policy makers believe the budget should be balanced except in times of war.
c.
the legislator who is a spending “watch dog” can save her constituents a substantial
amount of tax money.
d.
given the way Congress operates, the apparent popularity of deficit financing is surprising.
51. Since 1960, there have been how many years of budget surplus?
a.
5
b.
10
c.
20
d.
30
52. Sizeable budget deficits can be expected in the years ahead because
a.
the retirement of the baby boom generation will soon begin to push expenditures on both
Social Security and Medicare upward.
b.
the political incentive structure encourages politicians to spend more revenue than they are
willing to tax.
c.
both a and b are true.
d.
both a and b are false. Budget surpluses can be expected in the years ahead.
53. Which of the following is likely to push the federal debt increasingly higher in the coming decades?
a.
a strong rebound from the recession of 2008-2009
b.
increased expenditures on the Social Security and Medicare programs
c.
an increase in tax revenues as the baby boom generation retires
d.
increased political pressure to balance federal budgets
54. As baby-boomers reach retirement age and draw on Social Security and Medicare,
a.
the Social Security Trust Fund will switch from running a deficit to a surplus.
b.
unfunded promises included in the federal budget will decrease.
c.
expenditures on these programs will increase the size of the federal debt.
d.
the federal debt as a share of GDP will decrease.
55. If the federal government fails to reduce the nation’s debt relative to income,
a.
it will become easier to borrow in the global credit markets.
b.
the interest expenses on the outstanding debt will increase.
c.
the cost of holding outstanding debt will decrease.
d.
it will be easier to cover the interest on outstanding debt with tax revenues.
56. If a country with a large government debt uses money creation to service and repay the debt, this will
lead to
a.
lower interest rates.
b.
an appreciation of the nation’s currency in the foreign exchange market.
c.
inflation, higher interest rates, and a financial crisis.
d.
rapid economic growth, as the expansionary monetary policy stimulates the economy and
generates the additional tax revenue to service the larger debt.
57. What will happen if a country uses money creation to finance a large and expanding national debt?
a.
Real output and employment will grow rapidly.
b.
Nominal interest rates will fall.
c.
The foreign exchange value of the currency will increase.
d.
The rate of inflation will rise.
58. Which of the following best explains the political attractiveness of debt financing relative to taxation?
a.
Debt financing pushes the visible cost of government into the future.
b.
Debt financing exposes the current costs of government programs; taxes do not.
c.
Debt financing reduces the attractiveness of special-interest spending.
d.
Taxes allow politicians to supply voters with immediate benefits without having to impose
a visible cost.
59. During 2009 and 2010, the federal government financed approximately ______ percent of its spending
through borrowing. (Fill in the blank)
a.
20
b.
30
c.
40
d.
60
60. As the large baby-boom generation moves into the retirement phase of life, this will
a.
make it easier for the federal government to finance its budget deficit because the
baby-boomers will be the wealthiest generation of retirees in American history.
b.
make it easier for the federal government to reduce spending because senior citizens do
not spend much on consumption.
c.
make it more difficult for the federal government to finance its budget deficit because the
retirement of the baby-boomers will mean more expenditures for Social Security and
Medicare.
d.
not affect the federal deficit because there is no reason to expect that either federal
spending or tax revenues will be influenced by the retirement of the baby-boomers.
61. As the outstanding debt of a nation becomes very large relative to the size of the economy,
a.
the borrowing cost of the government will decline.
b.
lenders will have no choice but to hold the outstanding bonds and to buy the new ones as
they are offered.
c.
a country like the United States will have no choice but to default on the payments to bond
holders.
d.
if the country has a central bank, it will almost certainly resort to money creation to
service the debt rather than directly default.
62. If a country with a large government debt uses money creation to service and repay the debt, this will
lead to
a.
lower interest rates.
b.
an appreciation of the nation’s currency in the foreign exchange market.
c.
inflation, higher interest rates, and a financial crisis.
d.
rapid economic growth, as the expansionary monetary policy stimulates the economy and
generates the additional tax revenue to service the larger debt.
63. If the revenues and expenditures of the Social Security trust fund were not included when calculating
the budget deficit, the recalculated deficit would
a.
be larger.
b.
be smaller.
c.
be unchanged.
d.
actually be a surplus.
64. Which of the following is true concerning the national debt?
a.
It equals the budget deficit.
b.
When the budget deficit is declining, the national debt will fall.
c.
A budget deficit will reduce the national debt.
d.
A budget surplus will reduce the national debt.
65. If a budget deficit as a percent of GDP is greater than the growth of real output, the national debt will
a.
decrease relative to the size of the economy.
b.
decrease in nominal terms.
c.
increase in nominal terms but decrease relative to the size of the economy.
d.
increase relative to the size of the economy.
66. External debt is that portion of the national debt
a.
owed to investors outside the United States (foreign investors).
b.
owed to the Federal Reserve system.
c.
that the U.S. does not intend to repay.
d.
owed to U.S. citizens and corporations.
67. According to the traditional (crowding-out) view, which of the following is most likely to result if a
substantial portion of government expenditures is financed by borrowing rather than taxation?
a.
no change in interest rates and an increase in saving
b.
higher interest rates and an outflow of foreign capital
c.
higher interest rates and a reduction in private domestic investment
d.
lower interest rates and an inflow of foreign investment
68. Inclusion of the Social Security Trust Fund in the overall budget calculation
a.
reduces the reported size of the budget deficit because the Social Security system is
currently running a surplus.
b.
increases the size of the reported budget deficit because the Social Security system is
currently running a deficit.
c.
decreases the size of the reported budget deficit because the Social Security system is
currently running a deficit.
d.
increases the size of the reported budget deficit because the Social Security system is
currently running a surplus.
69. Which of the following is a valid concern about the national debt for a country whose debt is held
entirely by its citizens?
a.
The welfare of future generations will be directly related to the per capita size of the
national debt that they inherit.
b.
Growth of the national debt will eventually lead to the bankruptcy of the government.
c.
When the debt comes due, future generations may be unable to pay it off.
d.
If the increases in the national debt reduce private expenditures on capital formation,
future generations may have lower incomes because they will inherit a smaller stock of
capital.
70. The “implicit debt” accompanying the Social Security and Medicare programs is
a.
substantially greater than the national debt.
b.
approximately equal to the national debt.
c.
about half the size of the national debt.
d.
about one tenth the size of the national debt.
71. According to the traditional (crowding-out) view, budget deficits will
a.
reduce interest rates.
b.
increase interest rates and retard private investment.
c.
reduce the investments of foreigners in the United States.
d.
increase the capital stock available to future generations.
72. Given the underlying demographic changes in our society, we can expect
a.
budget surpluses to outnumber budget deficits in the years ahead.
b.
the number of budget surpluses to be approximately equal to the number of budget deficits
in the years ahead.
c.
budget deficits to outnumber budget surpluses in the years ahead.
d.
budget deficits one year to be followed by a budget surplus the next so that the budget
balances every two years.
ESSAY
73. What is the difference between the federal budget deficit and the national debt?
74. Many people assert that the national debt is not a problem because “we owe it to ourselves.” Is this
true?
75. According to the traditional (crowding-out) view, what impact do budget deficits have on the
economy?
ANS:
76. If the U.S. government were to run a substantial budget deficit, what would be the effects on the
economy under the new classical view?
77. Indicate what might be done to restrain the tendency of the democratic process to generate budget
deficits?