SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. Monetary and scal policies work with a lag. Monetary policy works with a lag
2. A dollar of additional government spending has a larger eect on GDP than a
3. There are many possible rules for monetary policy. One example is a rule that
sets money growth at 3 percent per year. This rule might be better than
4. The benets of reducing in.ation to zero include: (1) reducing shoeleather costs;
(2) reducing menu costs; (3) reducing the variability of relative prices; (4)
preventing unintended changes in tax liabilities due to nonindexation of the tax
5. Reducing the budget decit makes future generations better o because with
lower debt, future taxes will be lower. In addition, lower debt will reduce real
6. Our society discourages saving in a number of ways: (1) taxing the return on
interest income; (2) taxing some forms of capital twice; (3) taxing bequests; (4)
611
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Chapter 36/Six Debates over Macroeconomic Policy ❖ 612
Chapter Quick Quiz
1. b
Questions for Review
1. The lags in the eect of monetary and scal policy on aggregate demand are
2. According to traditional Keynesian analysis, a tax cut has a smaller eect than an
3. A central banker might be motivated to cause a political business cycle by trying
to in.uence the outcome of elections. A central banker who is sympathetic to the
4. Credibility might aect the cost of reducing in.ation because it in.uences how
quickly the short-run Phillips curve adjusts. If the Fed announces a credible plan
5. Some economists are against a target of zero in.ation because they believe the
costs of reaching zero in.ation are large and the benets are small.
6. Two ways in which a government budget decit hurts a future worker are: (1)
7. Two situations in which a budget decit is justiable are: (1) in wartime, so tax
8. The government can run a budget decit forever because population and
productivity continuously increase. Thus the economy’s capacity to pay o its
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 36/Six Debates over Macroeconomic Policy ❖ 613
9. Income from capital is taxed twice in the case of dividends on corporate stock.
10. Tax incentives to increase saving may have the adverse eect of raising the
Problems and Applications
1. a. Figure 1 illustrates the short-run eect of a fall in aggregate demand. The
b. With no policy changes, the economy restores itself gradually over time. The
recession induces declines in wages, so the cost of production declines, and
c. If policymakers are passive, the economy restores itself, but very slowly. If
Figure 1
2. It is di@cult for policymakers to choose the appropriate strength of their actions
because of lags between when policy is changed and when it aects aggregate
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 36/Six Debates over Macroeconomic Policy ❖ 614
3. a. If investors believe that capital taxes will remain low, then a reduction in
b. After the increase in investment has occurred, the government has an
c. Given the government’s obvious incentive to renege on its promise, rms will
d. This situation is similar to the time-inconsistency problem facing monetary
policymakers because the government’s incentives change over time. In both
4. Issues about whether the costs of in.ation are large or small are positive
5. The benets of reducing in.ation are permanent and the costs are temporary.
Figure 2 illustrates this. The economy starts at point A. To reduce in.ation, the Fed
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 36/Six Debates over Macroeconomic Policy ❖ 615
Figure 2
6. If the budget decit is 12% of GDP and nominal GDP is rising 5% each year, the
ratio of government debt to GDP will rise until it hits a fairly high level. (That level
turns out to be debt/income = 12/5, because at that point, a decit that is 12% of
7. a. An increase in the budget decit redistributes income from young to old,
b. More generous subsidies for education loans redistribute income from old to
c. Greater investments in highways and bridges redistribute income from old to
d. An increase in Social Security benets redistributes income from young to old,
8. The fundamental trade-o that society faces if it chooses to save more is that it
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.