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Chapter 30 Key Question Answers

30-2     (Key Question)  Assume that a hypothetical economy with an MPC of .8 is experiencing severe recession.  By how much would government spending have to increase to shift the aggregate demand curve rightward by $25 billion?  How large a tax cut would be needed to achieve this same increase in aggregate demand?  Why the difference?  Determine one possible combination of government spending increases and tax decreases that would accomplish this same goal.

30-3     (Key Question)  What are government’s fiscal policy options for ending severe demand-pull inflation?  Which of these fiscal policy options do you think might be favored by a person who wants to preserve the size of government?  A person who thinks the public sector is too large? How does the ‘ratchet effect’ affect anti-inflationary policy.

30-6     (Key Question)  Define the “standardized budget,” explain its significance, and state why it may differ from the “actual budget.”  Suppose the full-employment, noninflationary level of real output is GDP₃ (not GDP₂) in the economy depicted in Figure 30.3.  If the economy is operating at GDP₂  instead of GDP₃, what is the status of its standardized budget?  The status of its current fiscal policy?  What change in fiscal policy would you recommend?  How would you accomplish that in terms of the G and T lines in the figure?

30‑8     (Key Question)  Briefly state and evaluate the problem of time lags in enacting and applying fiscal policy.  Explain the notion of a political business cycle.  How might expectations of a near-term policy reversal weaken fiscal policy based on changes in tax rates?  What is the crowding‑out effect and why might it be relevant to fiscal policy?    In view of your answers, explain the following statement:  “Although fiscal policy clearly is useful in combating the extremes of severe recession and demand-pull inflation, it is impossible to use fiscal policy to fine-tune the economy to the full-employment, noninflationary level of real GDP and keep the economy there indefinitely.”

30-10   (Key Question)  How do economists distinguish between the absolute and relative sizes of the public debt?  Why is the distinction important?  Distinguish between refinancing the debt and retiring the debt.  How does an internally held public debt differ from an externally held public debt?  Contrast the effects of retiring an internally held debt and retiring an externally held debt.

30-13   (Key Question)  Trace the cause-and-effect chain through which financing and refinancing of the public debt might affect real interest rates, private investment, the stock of capital, and economic growth.  How might investment in public capital and complementarities between public and private capital alter the outcome of the cause-effect chain?