Chapter 12: Quiz Answers -- Fiscal Policy

1. Which of the following is not an example of an automatic stabilizer?
   welfare reform makes it more difficult to receive welfare even when the economy enters a recession. Welfare reform requires deliberate legislative action; therefore, it is not an automatic stabilizer. Welfare payments are automatic stabilizers, but actions to change the way that the welfare system functions are deliberate policy changes.

2. Fiscal Policy is often not very timely because of the long lags involved. Suppose the government recognizes the economy is going into recession and begins the process to reduce tax rates. The time it takes government to pass a tax reduction bill is called the
   implementation lag. This scenario is the definition of implementation lag.

3. All of the following are examples of contractionary fiscal policy except
   an increase in the discount rate. The discount rate is set by the Federal Reserve, not the federal government. It is an example of contractionary monetary policy. The others are examples of contractionary fiscal policy.

4. If the economy is experiencing a recessionary gap, the government should do which of the following?
   increase government expenditures. This answer is the only one that is expansionary fiscal policy, which is the appropriate response to a recessionary gap.

5. Suppose the economy is in a recessionary gap of $5,000 and the output multiplier is 4. By how much should government expenditures change in order to eliminate this gap?
   +$1,250 $5,000 / 4 = $1,250.

6. Fiscal policy is used less frequently than monetary policy as a stabilization tool because
   all of the above.

7. Supply-side economics argues that a cut in taxes will
   lead to a strong incentive for people to work more hours and invest in new capital. The increased hours and capital will, in turn, shift the Aggregate Supply curve to the right.

8. If tax cuts are implemented, supply-siders argue that deficits may not increase because
   all of the above. The Laffer curve demonstrates that if tax rates are so high that the economy is to the right of the tax revenue that produces the maximum tax revenue, then a cut in tax rates will actually increase tax revenue. Taxes so high distort incentives to produce and work.

9. An inflationary gap occurs when actual GDP exceeds potential GDP. This situation puts pressure on prices to increase.
   True. By definition, an inflationary gap occurs when actual output exceeds potential output. The tight labor market may lead to a wage-price spiral.

10. The 1980s experience with supply-side economics leads us to believe that we were on the left-hand side of the Laffer curve, i.e. a cut in tax rates led to a decrease in tax revenues.
    True. Deficits did increase sharply in the mid- to late-1980s after the tax cuts of the early 1980s. In fairness to supply-siders, government expenditures and especially transfer payments increased as well. Therefore, not all of the deficit increases were due to the tax cuts.