Chapter 12

Question 1

crowding-out effect

Answer 1

a reduction in private spending as a result of higher interest rates generated by budget deficits that are financed by borrowing in the private loanable funds market

Question 2

four economic approaches?

Answer 2

1. Keynesian
2. crowding-out
3. new classical
4. supply side

Question 3

K: discretionary fiscal policy

Answer 3

we should spend more and tax less during recessions (run deficits) and spend less and tax more during booms (run surpluses)

Question 4

Keynes and economic instability

Answer 4

believe that market economies have a tendency to fluctuate between economic booms driven by excessive demand and recessions resulting from insufficient demand

Question 5

C-O: when the government borrows to finance spending…

Answer 5

1. interest rates increase (thereby reducing business investment)
2. interest rates increase (thereby increasing saving and reducing consumption spending)
3. interest rates increase thereby increasing net foreign capital inflows - this increases the value of the dollar and reduces net exports

Question 6

C-O: expansionary fiscal policy

Answer 6

will have little or no impact on aggregate demand

Question 7

C-O effect…

Answer 7

• weaken or reduces the expansionary effect of deficit spending
• results in less private spending and can reduce capital accumulation

Question 8

NC: government deficits

Answer 8

since government deficits imply future taxes, they would have no net impact

people would anticipate future taxes so they would reduce consumption to offset the increased spending from government spending

Question 9

modern consensus view on stabilization policy

Answer 9

1. proper timing makes it difficult to run fiscal policy
2. automatic stabilizers help reduce fluctuations
3. fiscal policy is weaker than early Keynesians thought
4. each of the three demand-side views is sometimes correct

Question 10

supply-side effects

Answer 10

tax cuts can affect both AD and LRAS curves

Question 11

why do high taxes decrease output?

Answer 11

1. high marginal tax rates discourage work effort
2. high tax rates reduce capital accumulation
3. high tax rates encourage substitution of deductible goods for non-deductible goods

Question 12

supply side tax cuts

Answer 12

reduce marginal tax rates, reduce the tax progressivity; high tax rates do not necessarily produce high tax collections

Question 13

Keynesian tax cuts

Answer 13

view rate cuts as a less effective way to increase spending, aimed at increasing spending

Question 14

the three crowding-out effects

Answer 14

1. interest rates increase thereby reducing business investment
2. interest rates increase thereby increasing saving & reducing consumption spending
3. interest rates increase thereby increasing net foreign capital inflows this increases the value of the dollar and reduces net exports